Can the way stock information is presented lead investors to make the wrongdecisions? A new study in the Journal of Consumer Research shows that wheninvestors use charts, they are likely to make a baseless decision about theriskiness of a stock based on its run-length.
Stock graphs are everywhere, available on financial and public websites to beloaded and customized by users. Authors Priya Raghubir (New York University)and Sanjiv R. Das (Santa Clara University) found that investors believe thatstocks with shorter up-and-down movements are less risky than those with longerrun-length. This is called the "run-length" effect.
They tested three groups—affluent Californians, undergraduates, and generalinvestors—and found that all three judged a stock with a shorter run-length morefavorably. They found that the run-length effect increases with greater educationand frequency, length, and diversity of trading experience.
They conclude that because of the large amount of data presented on a graph,investors simplify their task by sampling points from a financial instrument'sprice history to estimate trend and noise. The sampling strategy leads toperceptual biases when the sample points are not representative of the priceseries.
The authors believe there are public policy implications that might lead to howdata is presented because "systematic biases in risk perceptions may permeate themarket uniformly, resulting in persistent biases in prices. . . From a consumerperspective, individual investors should be made aware of their biases inappraising and comparing stocks using charts."
"These results have implications for how financial information is communicatedto investors," the authors write. The visual display of stock information hasincreased and the number of commercial purveyors of stock analysis informationhas mushroomed…From a public policy perspective, regulators should considerimposing guidelines about how financial information is presented to individuals,akin to mandatory labeling by the Food and Drug Administration (FDA).