Researchers at the Massachusetts Institute of Technology have identified a thought-provoking phenomenon: people who consider themselves skilled investors have a greater tendency to engage in panic selling during times of market crisis, a frame of mind otherwise known as a “freak out.”
“The likelihood of panic sales and freak outs is most pronounced when the investor has self-declared good or excellent investing experience,” concludes the 3 August paper, titled When Do Investors Freak Out?: Machine Learning Predictions of Panic Selling. “Interestingly, those for whom we lack this information, and those who declared themselves to have no investment experience, are less likely to panic sell or freak out.”
Panic selling, a behaviour characterised as an investor intentionally liquidating large portions of risky assets as a response to significant losses, can be a stop-loss strategy used to protect a hard-earned nest egg.
But it has a downside, the authors contend. “We measure the opportunity cost of panic sales and find that, while freaking out does protect investors during a crisis, such investors often wait too long to reinvest, causing them to miss out on significant profits when markets rebound.”
The three occupational groups cited as having the highest risk of panic selling were those respondents who said they were self-employed, owners, or worked in real estate. The three groups with the lowest risk were paralegals, minors, and social workers. Unsurprisingly, researchers found that investors with no dependents were the least likely to panic sell. Younger investors are also less prone. Those over 45 years old showed a stronger tendency towards panic selling, while investors who are married or divorced are more likely to freak out than other groups. Many investors in the dataset did not provide gender information, but among those who did, males were slightly more likely than females to freak out.
More than statistics
To reach its conclusions, the studied relied upon a dataset of 653,455 individual brokerage accounts belonging to 298,556 households. The brokerage data provided to the researchers only recorded activities beginning from January 2003 through to December 2015. Analysed accounts were randomly selected from the population of US brokerage accounts that were still active at the end of 2015. Account numbers were anonymised.
Panic sales were defined as, “a decline of 90% of a household account’s equity assets over the course of one month, of which 50% or more is due to trades.” The study’s authors acknowledge that historically, financial crises are rare events.
Reluctant to re-enter markets
The researchers concluded that after investors participate in panic selling, many are reluctant to buy back into the market.
“As of 31 December, 2015, 30.9% of these investors have not taken on risky assets since they freaked out.” When an investor did enter the market again, about 58% held off for one to five months, and another 13% took a six- to 10-month break.
The study was conducted by Kathryn Kaminski, Andrew W. Lo, Kien Wei Siah, Chi Heem Wong, and Daniel Elkind. They concede that while they were able to confirm that panic selling occurs, they didn’t have the data required to address why investors engage in this behaviour. “This topic, however, would doubtless be an interesting direction for future research.”
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