Impact of Animal Spirit on Trade Performance: Moderating Role of Financial Literacy

Abstract

Behavioral biases play a vital and critical role in shaping the investor decision-making particularly in the emerging markets where informational inefficiencies are common. The current study investigated the impact of three behavioral biases which were mental accounting, anchoring and herding on the trading performance of the retail investors, while examining the moderating role of the financial literacy. Grounded in Prospect Theory and the behavioral finance paradigm this study employed the quantitative design used the survey data and collected 300 responses from the active retail investors in Khyber Pakhtunkhwa Pakistan. The data were analyzed using Partial Least Squares Structural Equation Modeling (PLS-SEM) to evaluate both the measurement and the structural models. The findings showed that the mental accounting, anchoring and herding each had significant negative effects on trading performance, indicating that heuristic-driven judgments reduced the investment efficiency. Financial literacy emerged as a significant moderator by weakening the negative effects of these biases and enabling the investors to make more informed and more rational trading decisions. The model achieved satisfactory reliability, convergent and discriminant validity and strong explanatory power with R2 of 57%. These results highlighted the importance of the financial education and cognitive awareness in improving the trading outcomes. The study contributes to behavioral finance literature by offering empirical evidence from a developing market context and emphasizing the practical implications for the policymakers, financial advisors, investor training institutions and trading platforms aiming to enhance the decision quality and the market stability.