With the growing popularity of retail investing, following the initial surge created by the 2020 COVID pandemic, understanding the trends of retail investors is critical. Retail investment can be defined as inflow from ordinary individual investors rather than large institutions. Common trends indicate that investors tend to buy at market peaks, rather than troughs, which does not align with typical expectations. This misalignment brings the critiques of rational retail investor behavior into attention, which may be driven by more than just logical analysis alone.
Firstly, increasing momentum in the market leads to sentiment driven behavior rather than rational behavior. According to the National Securities Depository Limited, retail demat accounts drastically rose in 2023 during the bull-run following the crash caused by the COVID pandemic in 2020. It would often be assumed that investors would buy when prices are low, however this may not be the case. The data indicates that investing behavior is driven by rising prices and momentum (or FOMO) rather than valuation based entry, demonstrating performance chasing behavior instead of counter-cyclical investing, challenging assumptions of rationality.
Similarly, from data by the National Stock Exchange of India, retail investors accounted for a higher share of the cash market turnover in 2021, meaning they held a larger portion of the total they held before COVID. At this time, there was greater momentum as confidence in the economy grew, hence the overall confidence of small investors increased as well, highlighting the role of momentum in investment.
Furthermore, in 2021, IPO oversubscription ratios exceeded 10x-50x, reflected in the retail investors accounting for higher shares of market turn over. This implies more people entered the market, showing the impact of momentum in leading herd behavior and narrative driven optimism instead of logical analysis. Simply put, investors follow trends of optimism.
Aside from momentum, biases also have an impact on retail investor behaviors. To look more closely at investment trends, extrapolation bias plays a role in trends where investors notice that the market is doing well based on recent returns, leading to the assumption that it will continue to rise. From the National Stock Exchange of India, this has been seen in positive twelve month index returns often being followed by an increase of investments. This is represented by higher net equity mutual fund inflows, indicating that the amount of money being invested into stock mutual funds is greater than the returns of the investment. The trend suggests investors extrapolate into future expectations by assuming past trends will continue into the future, demonstrating both recency bias and performance chasing behavior.
Also from the National Stock Exchange of India, in 2021 retail investors heavily invested even when P/E ratios were above the long-term averages implying that investors were entering the market at a time when expected future gains were compressed. Buying while P/E is high challenges rational retail investor assumptions since investing behavior is clearly influenced by overconfidence, herd behavior and fear of missing out, showing sentiment driven behavior as a result of biases.
Behavioral anchoring during bull-runs can also be noted where investors are anchored to a specific piece of information, in turn distorting their judgement. More specifically, recent peak levels act as an anchor resulting in “buy the dip” behavior (Reserve Bank of India Financial Stability Reports).
Since increasing reliance on the media as a source of guidance, the effect of this on investment trends should also be considered. According to the Securities and Exchange Board of India, brokerage apps and social media have been found to increase the effects of herding bias, where the platforms intentionally spotlight popular stocks and trades. This promotes collective trend following behavior, ergo challenging assumptions of rationality. Reliance on the media, rather than analytical thinking processes, is highlighted by increased searches of “How to invest in stock market” and rise of brokerage account openings during positive index returns and increasing momentum, highlighting collectivist behavior due to reliance on the media, reinforcing narrative-driven participation.
To emphasize on the role of the media in investment patterns, speculative phases where prices rapidly rise are often correlated with narrative amplification in the media. The connection between inflow and media output highlights its influence (Robert Shiller – Narrative Economics framework).
From this, it can be concluded that retail investment often aligns with economic trends of the business cycle, highlighting the prevalence of procyclical behavior. Resultingly, regulation or intervention may be needed to reduce herding, such as risk warnings or cooling off periods. Overall, the effects of momentum, biases, and media output on retail investor trends is clear, explaining the reasoning behind why retail investors buy at market peaks.