The overconfidence of traders

In a 2006 survey, researcher James Montier found that 74% of the 300 professional fund managers believed they had performed above average. The majority of the remaining 26% considered their performance as average. Almost 100% of the survey group rated their performance as average or good. Obviously, only 50% of the sample can be above average, suggesting a high level of irrational overconfidence among these fund managers.

As you can imagine, overconfidence (overestimating or exaggerating your abilities) is not a caracteristic that only applies to fund managers. Let's consider the number of times you've entered a competition believing that you have everything you need to win - regardless of the number of competitors or the fact that there can only be a single winner.

Keep in mind that there is a fine line between confidence and overconfidence. Confidence implies a realistic appraisal of one's abilities, while overconfidence generally implies an overly optimistic assessment of knowledge or control over a situation.

Overconfidence in trading

In terms of financial investments, overconfidence can affect your long-term trading ability. In a 1998 study entitled "Volume, volatility, price and profit when all traders are above average", researcher Terrence Odean found that overconfident investors generally trade more than their less confident counterparts.

Odean discovered that overconfident traders tend to believe that they are better than others at choosing the right investments and finding the best times to enter/exit a position. Unfortunately, Odean also found that, on average, traders who made the most trades tend to obtain returns that are significantly below those of the market.

Avoiding overconfidence

Professional fund managers that have access to the best industry investment reports and high-performance computer models can still fight for good returns and beat the markets. The best fund managers know that each investment day presents a new set of challenges and that investment techniques need to be refined constantly.