Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Investing: Overconfidence is dangerous - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Jul 13, 2009

    Investing: Overconfidence is dangerous

    In the previous article on 'availability bias', we discussed how analysts and investors get unduly influenced by their recent experiences in estimating the probability of an event. In this article, we shall examine another tendency called 'overconfidence bias'.

    What is 'overconfidence bias'?
    We have to exercise our judgment regularly in everyday life. We also have some amount of confidence about the accuracy of our judgment. An important question for investors is: what effect does more information have on our judgment? Also, how does more information affect the level of confidence that we place on our own judgment?

    As it turns out, several studies have shown that more information often does not increase the accuracy of our judgment but oddly makes us overconfident about it. In simple words, we tend to get misled by the quantity of information. Ironically, our confidence is particularly misplaced when the chances of our judgment being accurate is 50:50.

    The reason for this tendency is easy to understand. Sure footed decision making was critical for the survival of our ancestors. Earlier humans often had to act decisively based on little information in the face of uncertainty. Today, when it comes to stock picking however, the overconfidence bias can lead to irrational behavior.


    • Trading: The high trading volume witnessed in stock exchanges is based on the overconfidence of market participants. For every trade, there is a buyer and a seller. Both parties express confidence in their own judgment - after all, every trade basically says that my judgment on the price of a stock is superior to yours.

    Avoiding the overconfidence bias in stock picking

    • Admit: The first step in dealing with biases is to admit their presence.

    • Quality of information: We should realise that all information is not made equal. For example, the information we derive from reading the investment classics and multiple annual reports is qualitatively superior to other random news bits.

    • Stick to easy picks: Make sure that you stick to areas where your chances of being right are bright. As Warren Buffett says, "Easy does it... we have not learned how to solve difficult business problems. What we have learned is to avoid them... The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult."

    • Limit your bets to well researched ones: As Charles Munger, the vice chairman of Berkshire Hathaway says, "Even bright people are going to have limited, really valuable insights in a very competitive world when they're fighting against other very bright, hardworking people... it makes sense to load up on the very few good insights you have instead of pretending to know everything about everything at all times... How many of you have 56 brilliant ideas in which you have equal confidence? How many of you have two or three insights that you have some confidence in?"



    Equitymaster requests your view! Post a comment on "Investing: Overconfidence is dangerous". Click here!

    1 Responses to "Investing: Overconfidence is dangerous"

    chittaranjan kundu

    Oct 3, 2009

    I am learning from the tips you are providing. It is very tempting to be misled which is very hard to resist. let me practise it in day to day tradings.

    Equitymaster requests your view! Post a comment on "Investing: Overconfidence is dangerous". Click here!

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Were You Lured By Mr Market's Bait? (The 5 Minute Wrapup)

    Aug 23, 2017

    Mr Market lured investors into believing they'd bitten into a crash. Did you take the bait?

    Deep State First (Vivek Kaul's Diary)

    Aug 23, 2017

    Nowhere was the darkness deeper than in the nation's capital. There, no light shone. No flicker of awareness...observation...learning...or reflection appeared.

    Why Hasn't Warren Buffett Rung the Bell Yet? (The 5 Minute Wrapup)

    Aug 22, 2017

    It's surprising Warren Buffett hasn't warned investors about the expensive stock market? Let us know why.

    Think Twice Before You Keep Money In A Savings Bank Account (Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    More Views on News

    Most Popular

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)(The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working(Vivek Kaul's Diary)

    Aug 21, 2017

    Most Indians who cannot find jobs, look at becoming self-employed.

    It's the Best Time to Buy IT Stocks(Daily Profit Hunter)

    Aug 16, 2017

    The IT Sector could be in an uptrend till February 2019. Are you prepared to ride the trend?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Think Twice Before You Keep Money In A Savings Bank Account(Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 24, 2017 10:23 AM