Is Zero Return a Natural Benchmark for Investors? An Investigation with Individual Trading Records

Using a unique and large dataset of trading records, we find that individual investors view zero returns as a natural benchmark for their trading performance. They increase both buy and sell trading volume if their past investment outcomes are positive, and decrease them if the outcomes are negative, but appear to care much less for the size of the same outcomes (gains as well as losses). We also find that this trading behavior is non-rational; it results in economically significant declines in profits from current trades even without taking into account transactions costs. While our findings support the age-old knowledge that human thought processes are heavily influenced by the distinction between positive and negative numbers, our research strategy is motivated by recent research in experimental psychology that documents that individual subjects are more sensitive to the presence or absence of a stimulus than to its magnitude. Our findings provide new and empirically testable explanations for a number of extensively documented phenomena in finance and accounting, including excessive trading by overconfident investors.