Overconfidence

Confidence per se is not a bad thing, it helps to free us from the paralysis of analysis that comes from listening to the 'round the clock doom-sayers on the finance channel of Foxtel. Confidence becomes a real problem when it becomes overconfidence. Unfortunately, almost everyone overestimates their capabilities, in particular those with the self confidence to be in the market in the first place.

For example, the overwhelming majority of people, when asked, will tell you that they are outstanding drivers, and yet it doesn't take much thinking to realise that in every sample, at least half of all drivers will be below average. The same goes for traders. While the argument against the efficient market hypothesis is that the market actually doesn't process data very well, and that an ignorant herd do all the short-term price setting, it is interesting that everyone in that herd believes that they are privy to some sort of special information, perhaps derived from technical analysis, that enables them to out smart all the other investors.

Traders by nature are often supremely confident, they see themselves in a rather glamorous light as entrepreneurs making money by sheer brain power. They do vast amounts of analysis, and forecast the market like masters or the art, when all players think they have such special information, which the others do not, the result is a lot of trading.

Overconfidence is the basis of "irrational exuberance", the famous cautionary message by Alan Greenspan, and despite analysts warnings about overpriced valuations, investors stampeded right back into stocks.

Confidence, by the way, is one of the ways to recognise bad investment advice when you see it. If you pay for a seminar or book on investment, you should expect to hear nothing but good, solid investment information. The mark of the investment liar is a tendency to pad out investment related material with bags and bags of motivational stuff. All are designed to "empower" the trader to go out and take on the world, but this is irresponsible teaching, especially if it goes along with a message including negative gearing, option strategies and speculative penny stocks. Motivational material is the last great refuge for scoundrels, it is a way to sell the all purpose elixir without having to go through those tedious clinical trials. It is how Amway keeps its distributors buying expensive soap, it is how commission based sales staff perform a challenging but disparaged task week after week, even though they are spending more on phone calls and petrol than they are getting as income, and importantly, it is how shysters sell a dream and silence criticism.