Why Investors Get Fooled by Stocks like Tesla, Apple -- and Twitter

NEW YORK (MainStreet) — Did you buy Tesla a month ago at $190? Apple a year ago at $580? Groupon two years ago at $26? Don't beat yourself up; you can't help it. It's human nature.

Brad M. Barber, professor of finance at UC Davis and the Terrance Odean professor of finance at Berkeley, have studied the trading habits of thousands of investors and find most of us suffer from limited attention, overconfidence and, let's just say, bad timing.

The professors say the reason so many investors buy stocks when they are at their price peak is because that's when we pay attention. The media touts high-flying investments and most of us tend to buy, rather than sell, when those stocks are in the news.

"This attention-based buying can lead investors to trade too speculatively and has the potential to influence the pricing of stocks," write Barber and Odean in their research piece 'The Behavior of Individual Investors.' "Investors face a huge search problem when choosing stocks to buy. Rather than searching systematically, many investors may consider only stocks that first catch their attention (e.g., stocks that are in the news or stocks with large price moves). This will lead individual investors to buy attention-grabbing stocks heavily."

So you may buy Twitter at $45 on the day of its IPO's beginning value of $26, rather than waiting to buy on later, nearly inevitable, price weakness.

Barber and Odean note additional research that indicates that individual investors are more likely to trade a stock when a company's earnings announcement was covered in the investor's local newspaper.

But to make matters worse, many investors sell at the wrong time, as well.

"Individual investors have a strong preference for selling stocks that have increased in value since bought (winners) relative to stocks that have decreased in value since bought (losers)," Barber and Odean write.

"Investors buy stocks because of what they hope will happen and sell stocks because of what has already happened," say the professors. "When investors buy a stock (that they have not recently owned), they look to the past only to divine the future. Many investors employ the simple heuristic of assuming that the recent past is indicative of what is to come."

But Barber and Odean say the psychological trigger to sell a stock is different.

"When selling, investors are concerned about what a stock has done prior to the sale (and since being purchased)," they write. "In most cases, this leads investors to sell winners and hold losers, though, late in the tax year, investors tend to sell losers. It is unlikely that investors sell winners because they believe past winners are future losers; rather investors find it emotionally unpalatable to sell for a loss."

--Written by Hal M. Bundrick for MainStreet

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