Investor Regret Trading Strategy (23% Annual Returns)
How a psychological bias – the repurchase effect – predicts lower future stock returns. We show you a investor regret trading strategy.
The field of behavioral finance continues to uncover systematic psychological biases that influence investor decision-making and, consequently, asset prices. This article summarizes research on the repurchase effect, a form of investor regret that underlies a quantifiable, highly profitable trading strategy.
The article is based on the study titled “The Repurchase Effect and Asset Prices” by Haiqiang Chen, Ming Gu, Zhitao Xiong, and Jianfeng Yu.
This bias, often viewed as the counterpart to the disposition effect, centers on investors’ buying behavior rather than their selling tendencies. It documents that investors are reluctant to repurchase stocks that have appreciated after a prior sale.
This reluctance is systematically driven, researchers developed a novel stock-level measure called Repur. Repur quantifies the investors’ avoidance of repurchasing stocks after the price has risen following their sale, reflecting forgone gains of the month. 2. It aggregates the volumes of these trades, weighting them by the degree of forgone gains, and scales the result by the total monthly trading volume.
A higher Repur value indicates a stronger tendency for investors to avoid repurchasing those specific stocks.
The Trading Strategy: Exploiting Reduced Buying Pressure
The core finding of the research is the establishment of a significant negative relationship between Repur and future stock returns. Stocks burdened by high Repur experience reduced future buying pressure (i.e., less demand) from retail investors, which ultimately translates into lower subsequent returns.
This finding suggests a clear and highly profitable trading strategy:
• Strategy: Long stocks in the lowest Repur decile (P1, low regret/high future demand) and short stocks in the highest Repur decile (P10, high regret/low future demand).
• Economic Magnitude: This long-short portfolio yielded substantial annualized abnormal returns (Fama-French six-factor alpha, FF6), exceeding 23% on an equal-weighted basis and 11% on a value-weighted basis.
• Time Horizon: The return predictive ability of Repur is transitory and short-lived. The pricing impact is concentrated in the first month following portfolio formation, supporting a behavioral explanation consistent with the idea that feelings of regret are typically short-lived.
Robustness: Distinguishing Regret from Momentum and Disposition
The predictive power of the Repur measure is robust and not subsumed by other prominent market anomalies:
• Short-Term Reversal (STR): Although Repur and STR are positively correlated (0.56), the return predictive ability of Repur is not merely driven by short-term reversal. After controlling for STR in portfolio analysis, the long-short Repur portfolio still yields a statistically significant FF6 alpha of -0.94% (value-weighted).
• Disposition Effect (CGO): The Repur effect is distinct from the disposition effect (proxied by Capital Gains Overhang, CGO). When controlling for CGO, the Repur long-short portfolio remains robust, yielding an FF6 alpha of -1.08%.
• Other Regret Measures: Repur’s effect is also differentiated from the regret measure (ABT_REG) proposed by Arisoy, Bali, and Tang (2024), which uses industry-peer returns as counterfactuals. Separate analyses confirm that both measures possess distinct return predictive power.
Conditions That Amplify the Regret Effect
The pricing impact of the repurchase effect is not uniform; it is significantly more pronounced when market structure or sentiment exacerbates behavioral biases:
| Factor | Condition Under Which Repur Effect is Stronger |
| Investor Sentiment | Following periods of high investor sentiment. |
| Market Uncertainty | Following periods of elevated market uncertainty (e.g., high VIX or market volatility). |
| Arbitrage Constraints | For stocks subject to greater arbitrage constraints (e.g., high illiquidity, bid-ask spread, or idiosyncratic volatility). |
| Investor Base | For firms with smaller investor bases, where reduced demand has a stronger price impact. |
| Investor Type | When calculated using retail trades (Repur_retail), which exhibited substantially stronger predictive power than institutional trades (Repur_inst), supporting the behavioral nature of the bias. |
| Prior Gains | When investors had previously realized gains on the stock, indicating that the negative Repur-return relationship is stronger when prior gains heighten the sense of regret over a subsequent sale. |
Global Validation: Evidence from China
Out-of-sample evidence from the Chinese stock market further supports the validity and economic significance of the repurchase effect.
The Chinese market is characterized by a dominance of retail investors and significantly higher turnover rates (three to five times higher than in the U.S.). Consistent with the Repur effect being concentrated over short horizons, researchers implemented weekly rebalancing in China.
The results confirmed the pattern: the weekly rebalanced long-short portfolio in China yielded a monthly FF6 alpha of -1.98%, which is approximately twice the magnitude of the effect found in the U.S. market. This amplified effect strongly supports the argument that behavioral biases are more pronounced among retail investors.