OVERCONFIDENCE

It is common for traders to complain of a lack of confidence in their trading, but very often it is overconfidence that does them in. Overconfidence results from a lack of appreciation of the complexity of markets and an underestimation of the challenges of trading them successfully. In a sense, overconfident traders lack respect for the markets. They think that reading about a few setups or buying the newest software will prepare them to make money. Overconfident traders don’t want to work their way up the trading ladder: they resist the idea that screen time is the best teacher. They also chafe at the idea of growing their account. Rather than start with one contract and wait until they’re profitable before trading larger size, they want big positions—and profits—right away. Because they’re so eager to make money—and so sure they can make it—overconfident traders generally trade impulsively. They won’t wait for the setup to form; they’ll jump the gun—and get whipsawed in the process. Instead of being patient and waiting for short-term patterns to align with longer-term patterns, they will take every trade, enriching their brokers in the process.

The hallmark of overconfident traders is that they think they are going to make something happen in the market, instead of patiently waiting to take what the market gives them. Spelling out profit goals for each day or week of trading is one manifestation of overconfidence. Humble traders know that markets expand and contract their volatility—sometimes the trade just isn’t there. The overconfident trader, however, feels that he/she is bigger than the market. Indeed, overconfident traders will often take great pains to try to catch the tops of bull swings or the bottoms of corrections. As a result, they often fight the market trend—and can get run over in the process. If the emotional signs of perfectionism are anger/frustration and the emotional signs of ego involvement are elation/depression, then the emotional signs of overconfidence are impatience/impulsivity. Overconfident traders overtrade. They fear missing opportunities more than they fear losing money. The antidote to overconfidence is rulebased trading and the intensive rehearsal of trading rules. By making entries, exits, stops, and position sizing rule-governed and vigorously rehearsing trading rules during simulated trading (as well as in real time with small positions), traders can greatly reduce their impulsive trading. Very often this means training oneself to focus on (and rehearse) what-if scenarios of being wrong in the market, as well as forcing oneself to spell out the rationale, targets, and stops for all trades. By making trading a more self-conscious process, traders interpose thought between impulse and action, gaining greater control of their trading. When the trading room admonishes, “No boasting, just posting”, it is encouraging restraint on overconfidence.