The Influence of Holidays on Trading Behavior
Holidays are an integral part of daily life and can influence our behavior, ranging from social activities to investment decisions. A large body of research has found that anticipation of an upcoming holiday can lift mood and distract individuals from tasks such as information processing. The purpose of this paper is to extend the literature on trading activity before holidays by examining the cancellation behavior of limit orders by individual and institutional investors on the last trading day immediately preceding holidays including weekends and holidays such as the Chinese Lunar New Year.
Limit Order Execution and Monitoring
The anticipation of a holiday can be a distraction that leads individuals to pay less attention to financial markets and, for example, to fail to adequately monitor the process of limit order execution. This lack of monitoring may pose a risk to investors because limit orders are subject to the risk of adverse selection (pick-off) if prices change unexpectedly after the limit order is entered (Sandas 2001 and Linainmaa, 2010). As Liu (2009) and Fong and Liu (2010) show, limit orders are also subject to non-execution risk and free option risk. Therefore, investors could benefit from actively monitoring their limit orders and timely canceling their unexecuted orders when necessary.
Opportunity Costs of Monitoring the Market
However, the cost of monitoring the market may discourage investors from canceling stale limit orders in a timely manner. Because the arrival of information is random, traders must keep a close eye on the flow of information and the limit order book. This concentrated effort can be viewed as an opportunity cost that prevents investors from making another investment or pursuing other activities. These opportunity costs are particularly high on the trading days before the holidays, as investors could have spent their efforts on more pleasant activities vacation preparations.
Cancellation Behavior of Limit Orders Before Holidays
We use a Taiwan Futures Exchange TAIFEX dataset of timestamps of limit order submissions and cancellations to examine the cancellation behavior of limit orders before holidays. In particular, we find that investors take a long time before canceling their stale orders on the days immediately preceding holidays, suggesting that inattention before holidays imposes higher opportunity costs on monitoring the market. This result remains highly significant even after controlling for other forms of opportunity costs of monitoring limit orders, such as the relative proportion of other futures products traded on the same day. The result is also stable after controlling for non-execution risk and free option value risk of limit orders (Fong and Liu 2010).
Pre-Holiday Effect Across Different Investors
Furthermore, we examine the heterogeneity of the pre-holiday effect across different investors. Since trading is the responsibility of professional institutional investors, the cost of focusing on the market is assumed to be lower. Retail investors, who view trading as a fun activity (Dorn and Sengmüller 2009), are unlikely to monitor the market constantly. Moreover, to the extent that pre-holiday distraction reflects investors’ insufficient cognitive discipline, individual investors with low cognitive abilities are likely to pay less attention to the financial market and have a longer time to cancel, especially on trading days before holidays.
Complementing Previous Studies on Pre-Holiday Effects
To my knowledge, this is the first paper to study pre-holiday inattention separately for retail and institutional investors based on their monitoring of limit orders. Previous literature on pre-holiday effects has mostly focused on aggregate Google search volume or stock trading volume and returns (Dellavigna and Pollet 2009; Hirshleifer et al., 2009; and Lou 2014). Meshcheryakov and Winters (2022) show that higher levels of Google search activity are followed by more intense trading of smaller orders, suggesting that the increased trading activity is initiated by retail investors. However, they cannot rule out the possibility that smaller trades are made by algorithmic traders who closely follow the flow of information (searched for on Google). My work complements these studies by examining attention to monitoring the market through order cancellations. Inattention before the holidays is a quasi-natural shock to the opportunity cost of monitoring the market. Unlike aggregate measures of attention, the time to order cancellation can be obtained separately for different subsamples of investors. This allows us to examine the heterogeneity of pre-holiday effects for individual and institutional investors.
Poor Performance of Individual Investors
More importantly, this study uses limit order cancellations before the holidays to diagnose the poor performance of individual investors (Barber et al., 2009). While it is plausible to assume that people exhibit limited attention before holidays, it is not clear that this leads to losses. Suppose that all investors, savvy and unsavvy, buyers and sellers, reduce their monitoring efforts to a similar extent at the same time. In this case, investment performance could be unaffected, especially in a zero-sum futures market. My results show that the opposite is true. In particular, individual investors have a lower execution rate and significantly worse performance than institutional investors in the pre-holiday period. This result suggests that inadequate monitoring may be associated with a higher risk of non-execution and worse performance of individual investors. Determining why individual investors lose money relative to institutional investors-whether they lose more money when trading before holidays-brings light to our understanding of individual investor behavior.
Inadequate Monitoring and Higher Risk of Non-Execution
The study found that inattention before holidays may result in a higher risk of non-execution and lower performance for individual investors. This is due to a lack of monitoring of limit orders, which is more prevalent before holidays. The probability of execution before holidays is lower, and individual investors tend to have a longer time to cancellation and a lower execution rate compared to institutional investors on days preceding holidays.
Importance of Vigilance Before Holidays for Individual Investors
Overall, these findings suggest that inattention before holidays may lead to missed opportunities for individual investors, as they are more likely to experience non-execution of limit orders and have lower performance compared to institutional investors. Therefore, it is important for individual investors to remain vigilant and monitor their investments closely, especially during the days preceding holidays when market conditions may be more volatile.
trading activity, limit orders, cancellation behavior, individual investors, institutional investors, opportunity cost, monitoring the market, pre-holiday effect, cognitive discipline, performance, non-execution risk, futures market