NCPA - National Center for Policy Analysis

Online Trading Creates An Illusion Of Knowledge

July 12, 2000

The number of online stock traders has exploded in recent years. Ten million households are expected to trade online in 2003, representing $3 trillion in trading volume annually. However, many economists are urging caution. According to a recent study, online trading creates an illusion of knowledge that gives online traders less return on their investments. While online trader confidence rises with additional information, accuracy does not. As a result, traders are less likely to make a profit on each transaction and will make less profit on successful transactions.

The study finds that online traders:

  • Trade 96 percent more often than phone-based traders.
  • Are twice as speculative online as offline.
  • Underperform the market by 3.5 to 4 percent.

While online trading does cut commission costs, it also reduces the return on investment. The study concludes that while commissions can be expensive, they are generally worth it because of the added experience and caution that brokers add.

Source: "Online Investors: Do the Slow Die First?" Economic Intuition, Spring 2000. Based on Brad M. Barber and Terrance Odean, "Online Investors: Do the Slow Die First?" Working Paper.


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