Overconfidence Bias
Investors systematically overestimate their ability to pick stocks and time markets. Studies show that the average retail trader underperforms passive index strategies, primarily because of trading costs and poor timing. Yet investors continue to trade actively, driven by overconfidence. This bias generates trading volume that benefits market makers through PFOF and spread revenue.
Disposition Effect
Investors tend to sell winners too early (to lock in gains) and hold losers too long (to avoid realizing losses). This tendency — called the disposition effect — generates suboptimal return patterns and additional trading activity. Each trade generates execution costs (including PFOF-related costs) that accumulate over time.
Herding and Social Trading
Retail investors tend to follow each other's trades — a herding behavior amplified by online communities and social trading features. When many retail investors simultaneously buy the same stock, they may drive up the price, creating the appearance of successful trading. When the trade reverses, many suffer simultaneous losses. Herding generates large trading volumes at precisely the moments when liquidity costs may be highest.
The Market Structure Interaction
Behavioral biases that generate excessive trading are financially beneficial to the PFOF ecosystem. A retail investor who trades based on overconfidence, follows social media trends, or succumbs to platform gamification generates more trades, more PFOF for brokers, and more spread revenue for market makers. In The Ethics Reporter's view, market participants who profit from these biases have an ethical obligation not to actively exploit them.