Trader Dilemma: Trade immediately or wait and see?

Traders cannot wait

In the rush experiment, the results turn out as rationally expected: after only a few repetitions, most participants tend to act already in the first period instead of waiting for a further improvement of the already moderately good information situation.

In contrast, the results of the Wait experiment are surprising. Theoretically it was to be expected that due to the bad information quality a decision is made as late as possible, ideally only in the last period.

In fact, however, many participants act much earlier - even after several runs and correspondingly rather negative feedback of their hasty decisions.

The author attributes this to the fact that the participants follow a momentum-like strategy: Instead of making rational decisions about future developments based solely on the information available, they also react to the past course history. They only wait until they feel sufficiently confident to anticipate the most likely outcome and then act in that direction. In the course of the experiment, a certain level of necessary "certainty" is established on the basis of the accumulated historical information, at which point they are ready to make a decision. This behavior is surprisingly robust to learning effects and persists even after clearly negative experiences.

As is to be expected according to theory, the participants in the Rush experiment (left graph) act early and learn to trade mainly in the first period during the course of the experiment based on the predominantly positive results due to the already moderately good starting information. In the Wait experiment, on the other hand, they do not hold back until the end, as is to be expected in theory, but trade much earlier despite rather negative results due to the almost random start information.

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The premature action in the Wait experiment can also be justified by the fact that the participants are aware of their strategic interaction with each other. On the one hand, the available information is rather poor, but on the other hand, the costs of further waiting are overestimated - after all, the others might beat you to it. As a result, rather hasty decisions are made.

Conclusion

Many discretionary market participants tend to act prematurely - even if it would be much better to wait and see due to a poor information situation.

The study shows by means of a laboratory experiment that this is related to simple heuristics - in particular the procyclical behavior due to observed price trends (momentum trading). This can contribute to exaggerations both upwards and downwards and to prices becoming increasingly inefficient as long as a sustained trend dynamic exists.

Of interest in this context are systematic strategies that allow investors to benefit from such effects by means of clear decision rules. The advantage is that there is no additional level of interpretation with potentially distorting behavioral effects. Decisions are always made objectively, so that both positive and negative results are visible without distortion.