Introduction and growing popularity of discounted on-line financial brokers led to a significant increase in the number of investors with little or no knowledge of financial markets and investment. Some of these “unsophisticated” investors understand their lack of knowledge and ability to obtain and analyze the financial data and use on-line brokers mainly to invest into exchange traded mutual funds that track market indices. Other investors, however, take advantage of the low on-line commission fees to “play” on the market. Such investors invest in individual stocks and trade frequently based on the basic financial information that they can easily obtain on-line at a variety of investment-related websites (such as Yahoo Finance) or that is provided to them by their on-line brokers (such as E-trade or TD Ameritrade) free of charge. In this paper we investigate how such information affects the investment decisions of short-term unsophisticated investors.

This paper presents results of a two-round experimental study in which subjects (undergraduate students in various fields of specialization) were asked to buy stocks from a list of several comparable companies provided to them along with the basic financial information about these stocks. The subjects were given information provided by Yahoo Finance website about stock price, dividend yield, price to earning (P/E) ratio, and historical 52-week low and high stock prices (which can be used to get a rough estimate of volatility and long-term stock performance). In addition, to capture the information related to the short-term historical return presented by Yahoo Finance as a chart, subjects were provided with realized stock returns for the preceding two-week period. Thus, subject were able to base their decisions on short-term realized stock returns, on long-term (52 week) stock performance (by observing how the current stock price relate to its 52-week low and high values), and on some “fundamental” characteristics such as dividend yield, P/E ratio, and volatility (that can be proxies by the 52-week price range).

We found that, as a group, subjects (1) invest more in stocks with extremely high or low short-term realized returns, (2) invest more in stocks with higher short-term realized returns, and (3) invest more in stocks with lower long-term realized performance. We found that “fundamental” parameters, such as risk, P/E ratio and dividend yield, have no significant effect on the investment decision neither at a group no at the individual level.

By analyzing individual investment decisions, we found that a significant number of subjects simultaneously use momentum investment strategies based on the short-term realized stock returns and contrarian strategies based on the long-term realized stock performance. Furthermore, “short-term momentum” investors are more likely to follow contrarian strategies based on the long-term realized stock performance than investors who do not base their investment decisions on the short-term realized stock returns. By analyzing individual investment decisions in two rounds of the experiment, we found that a significant number of subjects do not change their momentum and contrarian strategies over time.