Trading Psychology | Overconfidence Bias – How Can I Ever Be Wrong?

Overconfidence is the unwarranted faith in one’s intuitive reasoning, judgments, and cognitive abilities. Studies conducted have shown that people overestimate both their own predictive abilities and the precision of information that they have been given. In addition, people are poorly calibrated in estimating probabilities – events which they think are certain to happen are often less than 100% certain to happen.

 

Overconfidence Bias – How Can I Ever Be Wrong?

 

In short, people think that they are smarter and have better information than they actually do. For example, they may get a tip from a broker or read something off the internet, and they’re ready to take action, such as placing a trade, based on the perceived knowledge advantage. If there is no logical basis for the advantage, then this perceived edge does not exist at all, despite what the trader thinks he knows.

There are two kinds of overconfidence – prediction overconfidence and certainty overconfidence. In prediction overconfidence, the confidence intervals that traders assign to their predictions are too narrow. An example of this is when gurus try to forecast precise price targets. In certainty overconfidence, traders are too certain of their judgments. For example, after entering a “sure-win” trade, traders become blind to the prospect of a loss, and then feel disappointed or surprised that the trade performs poorly. Always keep in mind that trading is a game of probabilities, and nothing is 100%.

How does this affect your trading?

“Too many people overvalue what they are not and undervalue what they are.”
– Malcolm S. Forbes

Cheers
Spencer
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Spencer Li is a trader, investor & entrepreneur who achieved financial freedom at 27 (2013), having to date accumulated a diversified portfolio of properties, stocks, REITs, and 10+ businesses across different industries. As a professional trader, he has over 10 years of market experience, and has been featured on more than 20 occasions in the media.

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