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   This is a translation of the former paper published by André Gosselin on the OrientationFinance.com web site on May 27 2005 ( Read the original paper in French here).


   The Web encourages investors to execute more transactions, and more speculative ones.


   * Paper written by André Gosselin published in "Finance et Investissements".

   The debate about the consequences of Internet on the financial markets and the investors' behaviours is far from its end. Would it be only as far as the organization of the stock exchanges is concerned, Internet could very well, one day, join together all the stock exchange markets of planet in one virtual and electronic site.

   Already, the parallel electronic markets like Island, Instinet and Archipelago unceasingly process an increasing number of transactions, without any human relay. It is not the case with the New York Stock Exchange and the Nasdaq where, despite all the progress in the order automation, they are still men and women who carry out the transactions.

   In 2000, the New York Stock Exchange counted, on its floor, more than 3000 persons executing an average of 671300 transactions per day. An electronic stock exchange like Island, counting 85 employees, executed 321007 transactions per day. The Internet network is just starting reinventing our stock markets and reducing their costs.

   As far as company management is concerned, Internet also reveals nice promises. As it is well known, a great proportion, if not the majority of the small investors do not vote on the proposals submitted by the company directions to their shareholders.

   Electronic vote on Internet could soon change this situation and create a greater feeling of participation and responsibility among the individual shareholders. They could vote on questions about the companies' social responsibility as well as on questions which relate to the good governance or the strategic directions of the companies.

   Internet would finally provide a platform enabling the discussion of significant questions, the formation of coalitions and should lead to a larger number of people to vote. On all those subjects, the companies' democracy would be improved.

   As far as investors and broker firms are concerned, finally, Internet has created a revolution which radically changes the practices and mentalities. Some commentators have raised the idea that the Internet expansion in discount broking and among individual investors is the main cause of the daily volume and volatility increase of the stock market transactions; moreover, it is undoubtedly the most significant factor at the origin of the creation of the speculative bubble of the high technology securities at the end of the 90s.

   illusions of control and knowledge

   One thing is certain: Internet has made possible to the investors to have access to a mass of information thousand times more significant than all they knew before.

   They can exchange opinions between them thanks to discussion forums, read all the annual reports they want, consult news archives and press releases about any company, know in real time the price fluctuations, devote themselves to the technical analysis of stock exchange graphs, select, using research filters, the securities which answer the best to their selection criteria, and even more.

   These quasi unlimited possibilities, which exceed the anticipation scenarios of the most imaginative futurologists, arise fears of several researchers. They are afraid of Internet causing two phenomena well-known of the psychologists: the illusion of control and the illusion of knowledge.

   The professors of finance Brad Barber and Terrance Odean have particularly insisted on these two phenomena. Their studies provide elements of proof according to which the individual investor, in particular the Net surfer, would be a beautiful case where the illusion of control and the illusion of knowledge appear at high level, with for ultimate consequence the demonstration of an harmful and detrimental behaviour: the excess of confidence.

   Result: the portfolio returns of the autonomous investor suffer a lot from it.

   As the researchers write it so well: "When the individuals receive more information to make a forecast or to pose a diagnosis, the confidence in their judgement increases much more than the intrinsic veracity of this one."

   In fact, it happens very often that the value of some forecasts declines as information increases, because of the overflow of information, also called information overload by some psychologists.

   Terrance Odean and Brad Barber have showed that the investors who forsake their adviser and their full-service broker to take charge of their placements by themselves with an on-line broker execute a larger number of transactions, and those ones have the disadvantage of being more speculative.

   While becoming more autonomous with Internet, the investors have increased their portfolio turnover rate from 70% to 120% per year. It seems, conclude the two Californian professors, that there is a price to pay when one decides to forsake his broker to do everything by himself though Internet, and this price is a fall of the portfolio return.

   It would be hazardous to claim that Internet is the only raison why the investors are unsuccessful. Many factors explain the traps into which they fall too often and the setbacks that too much of them could have known. But it is necessary to face facts: Internet has heightened some shortcomings the investors have always got or it has acted as a catalyst in a decision-making process which appears, altogether, poor.

   To be continued in Part 2.

   André Gosselin

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