Overconfidence in investing
Overrating one’s own knowledge and skill in picking investments, which shows as frequent trading, concentrated bets and certainty about timing. It often comes with herding, buying what others are buying, and with constant checking of prices.
What drives it
Confidence makes acting possible under uncertainty and makes wins feel earned. For identification it explains why a person keeps trading after costs eat their returns, and why losses get blamed on the market while gains are credited to skill.
How it shows
Work
Price apps open during meetings, talk of a stock that ‘can’t lose’, moving savings in and out after headlines, quoting the gains and not the losses, joining every trade the group chat is excited about.
Relationships
Moving joint savings without discussion, a partner finding the trading account, the story of one big win repeated at dinner while the running total is never mentioned.
Self
Notice how often you check prices, whether you can state your total return after fees for last year, and whether you remember your wins more clearly than your losses.
What tells it apart
Illusion of control: Illusion of control is believing one can influence chance outcomes. Overconfidence in investing includes that, and also overrating one’s information and forecasting skill.
Gambling disorder: Gambling disorder involves loss of control, chasing losses and harm despite repeated attempts to stop. An overconfident investor may trade too much without those signs, though heavy trading on apps can cross into it.
Dunning-Kruger effect: Dunning-Kruger describes low performers overrating their skill. Investor overconfidence appears in experienced, well-informed investors too, and is better seen in how often they trade than in test scores.
A test
Ask for the total return after fees over the past year compared with a simple market index. Not knowing, or a figure below the index alongside high certainty about the next trade, makes overconfidence more likely.
Questions to carry
- When the trade went wrong, what reason did the person give, and was it the same kind of reason given for the wins?
- What is my actual return after fees, and why don’t I know it?
How strong the research is
moderate. In data from 66,465 US households at a discount broker, 1991–1996, Barber and Odean (2000) found the fifth who traded most earned 11.4 per cent a year net against 17.9 per cent for the market, and men traded 45 per cent more than women (Barber and Odean, 2001), which they read as overconfidence. The trading pattern is well documented, but overconfidence is inferred rather than measured directly, and Bonaparte, Cooper and Sha argue that a model of rational investors facing trading costs can produce the same pattern.
Where it comes from
Brad Barber and Terrance Odean, 2000 (Trading is hazardous to your wealth) and 2001 (Boys will be boys)