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Individual investors are consistently outperformed by companies and short sellers in the stock market, according to a new study published in the November 2025 issue of the Journal of Financial Economics. The research, titled “Taking Sides on Return Predictability,” conducted by R. David McLean, Jeffrey Pontiff, and Christopher Reilly, analyzed trading patterns across nine different types of market participants to determine who makes smarter investment decisions.
The study represents the most comprehensive analysis to date of market participation, examining the trading behavior of six types of institutional investors – mutual funds, banks, insurance companies, wealth managers, hedge funds, and other institutions – alongside corporate insiders, short sellers, and individual investors. Researchers analyzed trading patterns across 130 different stock market anomaly variables, characteristics identified by academic research as predictive of future stock performance. They measured changes in ownership over one- and three-year periods preceding the construction of these anomaly variables, revealing how each market actor adjusted their holdings in anticipation of portfolio formation.
The analysis revealed a clear distinction between “smart money” and those consistently making less informed trades. Companies themselves proved to be the most informed actors. When companies issue or repurchase their own shares, they consistently craft advantageous decisions. Firms with the lowest expected performance were most likely to issue shares, while those with higher expected performance were more inclined to buy back stock. The researchers found that the 130 predictive variables explained 32% of the variation in share issuance over a three-year period, and even after accounting for all public information reflected in those variables, corporate trading still predicted future performance.
Short sellers were identified as the second most informed group. They systematically targeted stocks with low expected performance, and their trades foreshadowed weaker future returns. Still, the predictive power of short sellers largely disappeared once researchers accounted for the 130 anomaly variables, leading the authors to conclude that, unlike corporations, short sellers do not appear to possess much non-public information; their success stems from the effective leverage of publicly available data.
Individual investors fared the worst. They consistently made the poorest trading decisions across the board, buying stocks with low expected performance and selling those with high expected performance. Their cumulative trades over one- and three-year periods predicted returns opposite to their initial intention. The 130 anomaly variables explained 18% of their trading patterns over three years.
Interestingly, the study uncovered a paradox regarding individual investors. While their cumulative trading over the long term predicted poor performance, short-term spikes in their trading activity (measured weekly) actually predicted positive performance. This finding aligns with previous research, leading the authors to conclude that “temporary spikes in retail trading…predict performance in the intended direction, while retail trading aggregated over long periods…predicts performance in the unintended direction.”
Institutional investors, as a group, proved largely neutral. None of the six types of institutional investors demonstrated a consistent ability to predict performance. All institutional groups held more stocks with low expected performance than those with high expected performance, contributing to market anomalies. The anomaly variables explained 5% or less of institutional trading over three years, suggesting their transactions were largely random with respect to future performance.
The findings regarding hedge funds were particularly noteworthy. While hedge funds excel at short selling, their long positions in stocks were poorly positioned relative to the anomalies, failing to predict good performance.
The study’s findings suggest that investors should approach stock picking with humility. Given that professional institutional investors with substantial resources struggle to consistently select winning stocks, individual investors should be realistic about their chances. The data demonstrates that individual trading decisions tend to underperform. Investors should consider following corporate insider activity, paying attention to share repurchase and issuance programs, as a potential signal. A large increase in share repurchases often indicates a positive outlook, while a significant share issuance may suggest management believes the stock is overvalued. The study as well suggests that high short interest is not simply market noise, but reflects informed analysis, and that frequent trading can be detrimental to performance.
Given the difficulty even experienced institutional investors face in positioning themselves advantageously, systematic, passive index/quantitative investing becomes even more attractive.
The research paints a concerning picture for active investors. The most informed participants – companies trading their own shares and short sellers – possess clear informational and analytical advantages. Meanwhile, individual investors and institutions struggle to position themselves on the right side of predictable performance patterns.
