How Overconfidence Bias Can Affect Your Trading

Winsor Hoang |

Virtually everyone can agree that confidence improves our success rate. When one is confident, they are more likely to take risks or look for opportunities. They can also internalize the belief that they can complete tasks successfully. Thus, confidence is a necessary characteristic that we all strive for, including Forex traders. However, too much of a good thing can have negative results. And there are a number of traders who are suffering from overconfidence.

Overconfidence bias isn't simply feeling as if you can handle everything, it's an inflated belief in your skills as a trader. While most Forex psychology classes often breach against fear, it's important that traders understand how and why over confidence can prevent a trader from becoming consistently profitable.

1. Overtrading

One of the common symptoms to overconfidence is over trading. This can be done by trading too frequently, taking extremely large trades, or taking uncalculated risks. Overconfident traders can believe they are so “well equipped” with the right skills that they do not properly money management. If they did they would realize their overtrading can have disastrous effects. They are often so focussed on making large gains, and believe they have the ability to do so, that they forget traders can both lose and win in the field of Forex. Overconfidence psychologically sets traders up for making mistakes, because they don't prepare for the loss.

2. Using Outdated Techniques

Forex is an ever-changing field, but if a trader feels they already know everything, they will inevitably outdate themselves. This happens when traders no longer seek up to date information on trading techniques and technology. This causes them to use methods that no longer give them an edge. They will also neglect to apply useful forms of technology that can improve their trades and make the process of trading more effective. Overconfidence can make a trader closed-minded and this is not a field where one can afford to have their ego prevent them from looking for new information or build new skills.

3. Lack of Testing

Overinflated egos do not test their techniques, plans, and systems as often as need be. To say testing is important in Forex, is an understatement. It's vital! However, a trader who is overconfident about their technique and system, is less likely to make frequent vigorous testing a priority. Those that suffer from overconfidence bias do not want to have the face the fact that they may be wrong. The ego doesn't want them to challenge their own thinking or their plan. This prevents them from analysing, discovering, and fixing problems in their plan. Traders need to test and retest their techniques and systems in order to ensure they can create consistent profits.

4. Often Neglect the Bigger Picture

A trader can assume they are a “guru” after they manage to make a few good trades. They assume their skills are proficient simply because they had luck on their side. What they don't take into consideration is whether or not their technique and system can produce positive outcomes in the long run. A few good trades isn't good enough in Forex. One needs to know they have built an edge that can create consistent profits for the long haul. An overconfident trader can fail to look at the bigger picture, which can take them out of the Forex journey sooner than they had hoped.

Overcoming or preventing overconfidence bias requires that you understand that your ego is vulnerable and wants you to believe you perfect trader. But no trader is perfect. This is why a trader should set up and stick to strict money management rules. The more a trader focuses on money management, the less likely the will rely on their overinflated ego to direct their trading.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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