💵 The Retail Detail

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Retail is Detail. A well-known phrase that describes what's required to succeed on the high street or in e-commerce.

The basic premise is that each part of a retailer's offering must be correct, right down to the most granular level, if they are to outperform their competition.

I would suggest that this idea is also applicable to Retail Traders, that they need to pay attention to the whole just as much, and perhaps even more than the grocers and merchants do.

Both groups often operate on thin margins which can be quickly wiped out by miscalculations. For example, Target's stock control or the ASOS returns policy.

In this article, we'll look at several pieces of research and commentary that exemplify why it's so hard for retail traders to make money (or more importantly, to keep the money they make).

Let’s start with the rise of social trading and the idea that by combining forces and sharing information, retail traders could get one over on Wall Street...

Lasse Heje Pedersen of hedge fund AQR Capital did some research on this. The full paper can be found here.

Pedersen examines the behaviour and evolution of different types of traders, the social networks they used, and the price action seen in meme stocks in 2021...

Now, social networks are nothing new to investing and trading. They can trace their roots back (at least) to the 17th century. Standage 2006 suggests that:

Pedersen identifies different types of traders, including

• Naive investors

• Fanatics

• Longer-term & rational investors (the importance of rationality and critical thinking crops up regularly in the Macrodesiac chats)

Pedersen's investor types reminded me of work 'on human stupidity' by Carlo Cippola at the University of California, Berkeley in 1976.

Cippola identified what he called phenotypes or observable traits in human behaviour. He divided these into a graphic like the one below. 👇

Cipolla wrote:

Beautifully harsh. For an overview of Cipolla's essay on stupidity see here

Back to Pedersen. In his paper, he notes that the views of fanatics and rational investors come to dominate over time.

The fanatics, perhaps form what is often referred to in our discord as a very vocal minority.

Furthermore, Pedersen draws the (obvious?) conclusion that the relative importance or weighting of these views depends on the following these groups have, within the social networks, and in the wider market through what he calls social network spillovers.

The chart sets out some of the stages in the cycles identified in his research. 👇

A review of Pedersen's paper by Dr Elisabetta Basilico sums up the findings rather nicely.

The lesson? Form your own opinions, don't be reliant on others (to avoid bubble/fanatic mentality) and time your entry and exits based on your own criteria rather than when everyone else heads for the exit.

Earlier in May Larry Swedroe the head of research at Buckingham Financial reviewed a paper by Ryan Chacon, Thibaut Morillon, and Ruixiang Wang, (published in June 2022) that also looked at the phenomenon of social trading.

Specifically Wall Street Bets and its army of Redditors.

The trio examined whether WSB and its followers generated investing alpha.

Their conclusion was that they didn't. Unsurprising perhaps. Furthermore, investing in a portfolio of long and short tips from WSB would not be profitable on a risk-adjusted basis.

The academics also looked at the posts of the top 40 WSB posters by message volume and examined the individual performance of their recommendations.

There was a wide dispersion of results with a range of almost 30% (14.86% to -14.73%).

However, when they calculated the average Cumulative Abnormal Returns or CAR among the group they reached a mean of just 0.25% and a median return of just 0.38%.

In simpler terms

The academics concluded that while WSB recommendations induced trading activity (great for brokers and Kenny G)...

Adding that:

Larry Swedroe reinforced those findings by drawing a comparison with a social trading ETF writing that:

Those final comments may seem harsh, but they are probably true for the rank-and-file retail investor or trader.

Part of the Macrodesiac mission is to simplify these puzzles for our audience to the point that they no longer fall into that category.