Nearly 10% of stock market investors trade as if they are gambling. This leads to more trades and more money on the market, but yields much lower returns for the investors. We should acknowledge this behavior and boost financial education and risk assessment, rather than assuming that investors are perfectly rational.

In the past few decades, the rise in prosperity in Asia has made it easier for Asians to engage in stock trading. Some do this as a way of diversifying their savings. But research shows that up to 10% of traders partake in stock trading as a form of gambling.

Policymakers must recognize that those who trade stocks are not all making choices according to economic rationality, and take measures to mitigate social and economic risks.

Do People Really Treat Stock Trading as Gambling?

Can stock trading really be considered gambling? To investigate this, I, along with several colleagues, looked at the following case in Taiwan.

A standard lottery ticket in Taiwan costs NT$50 (US$1.60). With some stocks nowadays costing less than US$10 per share, people are able to choose between investing and gambling, as the cost of entry is often very similar. So we decided to compare the two activities to gauge whether the Taiwanese see stock trading as a form of gambling.

Large lottery jackpots significantly reduce individual trade volume among stocks that are favored by retail investors.

We posited that if this is indeed the case, then large lottery jackpots would lure retail investors (those who trade for themselves rather than organizations) away from stocks as they substitute one form of gambling for another. This is particularly pertinent in Taiwan as retail investors make up 70% of trade volume on the Taiwan Stock Exchange.

Our results showed that large lottery jackpots significantly reduce individual trade volume among stocks that are favored by retail investors. On days when the lottery has large jackpots (in excess of NT$500 million, or US$15 million), stock trading falls in general. These falls range from 5.2% to 9.1%. For stocks that are more lottery-like (i.e. they have a small probability of a large return), trade volume declines between 6.8% and 8.6%. Interestingly, the trade volume of stocks favored by institutional investors such as mutual fund managers are unaffected on the same days. “Boring” stocks that do not exhibit periodic return spikes are not affected either.

In sum, at least some retail investors in Taiwan trade fewer stocks on drawing days of large lottery jackpots. This suggests that they trade stocks partly out of a desire to gamble.

Financial Market Ramifications

So, the trade volume of stocks with lottery-like features declines on drawing days of large lottery jackpots. What effect does this have? We found that large jackpots may reduce stock liquidity as the closing bid-ask spread, a measure of stock liquidity and trading cost, increases on large jackpot drawing days. This seems to indicate that the presence of retail investors who engage in irrational behavior is likely to improve stock market liquidity.

This is a surprisingly positive influence on the quality of the stock market, as stocks with better liquidity can offer some benefits to investors. Greater liquidity makes it easier to buy and sell without taking a price hit.

However, investing in stocks with lottery-like features can lose investors money. Moving our setting of study from Taiwan to the United States, we found that investing in such stocks tends to yield lower returns. This is a phenomenon that only exists among stocks preferred by retail investors, as opposed to those usually traded by institutional investors.

Stocks favored by retail investors tend to be small ones. Although these stocks account for half of all listed firms, they make up less than 5% of the overall market capitalization. This indicates that stocks with lottery-like features are likely to underperform.

“8” For Prosperity

Another investing pattern that points to retail investors approaching stock trading irrationally, as if they were gambling, is that some investors favor stocks that feature “lucky” numbers. In Mandarin, “8” is a near-homophone of “prosperity,” while “4” is a near-homophone of “death.” The 2008 Beijing Summer Olympics opened on August 8, 2008 at 8:08pm for this very reason. And, as many have noted, some buildings in China do not have a fourth floor.

Retail investors in Taiwan submit disproportionately more limit orders ending with “8” than “4.”

We have found that retail investors in Taiwan submit disproportionately more limit orders ending with “8” than “4.” The submission ratio of prices ending in “8” is 0.098; the ratio is a significantly lower 0.063 for prices ending in “4.” We cannot observe the same imbalance in the behavior of institutional investors, whose submission ratio of prices ending in “8” and “4” are 0.103 and 0.100 respectively.

This irrational behavior has important implications. We found that superstitious investors who trade more at “8” than at “4” tend to lose money compared to those who do not exhibit number superstition.

Towards Better Financial Policy

When he received his Nobel Memorial Prize in Economic Sciences in 2017, Richard Thaler said, “Incorporating human behavior into economic models improves the accuracy of economics, just as ‘cryo-electron microscopy’ improves the resolution of images in biochemistry.” It is important that we understand why economic actors (in our case, stock market investors) do the things they do.

My belief is that we could improve the design of financial regulations and policies to better protect retail investors, especially as the barrier to entry into the stock market gets lower and lower. Two obvious points of focus are financial education and risk assessment. A better understanding of retail trading behavior would greatly increase the effectiveness of financial education. And more effective education would alleviate the irrationality with which some investors operate, and help curb social problems that could arise from retail investors losing money on the stock market. Likewise, financial institutions that specialize in retail trading could minimize disputes if they were better equipped at managing excessive risk-taking by clients who treat stock trading as a form of gambling.