Overconfidence in Trading

A few winning trades in a row can make you feel you have figured the market out. That feeling is very natural, but it sometimes leads people to trade bigger or more often without asking: was that gain skill, or was the whole market rising?

What does overconfidence look like?

Confidence in yourself is not the problem, quite the opposite. The problem is when it grows bigger than what the numbers say. It usually shows up in three forms: feeling that you can tell where a stock is going, putting more money into a trade after a few wins, and trading a lot because every move looks like "an opportunity".

The reason is that the mind easily credits gains to our own skill and blames losses on luck or on the market. So after a few winning trades, the picture we hold of ourselves is rosier than reality.

Example: three wins and one trade

Trade 1

10,000 +4% = +400

Trade 2

10,000 +5% = +500

Trade 3

10,000 +6% = +600

Trade 4

40,000 -10% = -4,000

Net result-2,500

Invented numbers. The bar length is the amount put into each trade.

ExampleYou made 3 trades of EGP 10,000 each and gained 4%, 5% and 6%, EGP 1,500 in total. Feeling you had cracked it, you put 40,000 into the fourth trade. It fell just 10%, a loss of EGP 4,000. The net result is a loss of EGP 2,500, even though 3 of the 4 trades were winners.

Notice that the loss did not come from the analysis suddenly getting worse. It came from the trade size growing because of a feeling, not a plan. Each extra trade also carries fees, which your brokerage firm can tell you about, and they eat into gains over time.

Watch outWhen the whole market rises, most stocks rise with it. If you gained 15% over a period in which the index rose 18%, your result was below that index as a reference, not above it.

How to measure yourself calmly

Log every tradeThe reason, the amount and the result. Our memory can be selective, and a log stops us relying only on what we remember.
Compare with a suitable indexCompare your performance with an index that suits what your portfolio holds, over the same period. It gives you a reference for whether your result was above or below the market move, but on its own it does not prove the difference was skill or luck.
Keep trade size steadyDecide in advance what share of your money goes into each trade, and do not change it just because you won a few times in a row.

Compare your result with a reference

Open the indices page, pick an index that suits what your portfolio holds, and see what it did over the same period. That gives you a reference for whether your result was above or below it.

Indices Portfolio

Check yourself

1. You gained 12% in a year while the index rose 20% over the same year. How did you do against that index?

A gain alone is not enough. 12% is less than the 20% of the index used as a reference. That alone does not say why.

2. In the example, what turned three wins into a net loss?

10% of 40,000 is more than all the earlier gains combined.

Summary

Repeated gains can inflate confidence beyond what the numbers show.
Growing a trade because of a feeling can wipe out the gains of many trades.
Log your trades and compare your result with a suitable index over the same period, as a reference rather than a verdict on your skill.

Related terms

EGX30 index Stop-loss

Related lessons

Educational content only, not investment advice. Companies and figures in the examples are invented for illustration.