Behavioral finance FAQ / Glossary (Overconfidence)
This is a separate page of the N-O section of the Glossary
Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed, i: incidental
Overconfidence bias, overconfident
(+ under confidence)
Seen in many messages, as a BF classic +
see attribution, certainty effect, under confidence,
optimism bias, illusion of control / of knowledge,
winner'scurse, perverse effect, narcissism,
magical thinking, greater fool
I'm the best poker player in town. And the best gun.
I'm dead sure I cannot lose any bet!
As you can read on my tombstone.
Better be self-confident to take initiatives and make
progress, or better say, just to live, but too much of the
good thing can be fatal
An overconfidence bias is seen when somebody relies
too much on his
own judgment, foresight and abilities.
This bias does not leave much room for adaptation to realities and is a source
of wrong decisions.
This can encompass various illusions (see the "illusion" glossary page).
For example, various common traits can be found with the illusion of competence.
In its extreme form, it can verge on a systematic certainty (see certainty effect /
pseudo-certainty) to be right, a mental blindness (see selective
perception), narcissism, illusion of control and magical thinking (see the related
How to be overconfident...
...or preferably not.
Overconfidence can result either from inexperience or from self-admiration (and sometimes
The overconfident person tends to:
Overestimate the chances of success of its own moves
It reflects an illusion of control / of competence / of knowledge / of
It might include some magical thinking and narcissism (see
Those are typical biases for people with an extreme belief that luck is always
in their side. They might not realise that, in their previous successes, luck had
its place and luck tend to regress to the mean.
Underestimate the associated risks (and perverse
effects) of its decisions.
In both aspects, overestimate the rightness of its own thinking.
What does it leads to?
are not always
although they might
Overconfidence is a biased self-centered anticipation
that can cause
Either over-optimism (see optimism)
This is the case when taking a naive initiative on
what is an apparently favorable situation,
while neglecting to explore all the pitfalls and
drawbacks, and see for example the base rate
(see that phrase) of success of comparable
As well as over-pessimism
This is the case for example when deciding not
to take such an initiative, by considering those
prospects as doomed from the start, without
exploring all its possibilities.
are not always
although they might
Overconfidence can lead to:
Either rushing into not well thought and poorly
informed wild moves, overtrading for example,
Or on the contrary delaying (see that word)
decisions about needed changes of practices.
A self-attribution (see attribution) of past successes or
failures can trigger those feelings.
Individual and group overconfidence
Blinded by the crowd.
As reality is a bore (?), overconfidence is rather common in most aspects of life.
It can be:
Either an individual attitude.
For example, most car drivers think their abilities as superior to those of the
other members of the motorized crowd
Also, for some people, overconfidence reaches extremes of self admiration
and becomes narcissism (see that word).
Or a group contamination.
People who belong to a group (corporation, profession, organization, ethnic group,
* Tend to be more confident than when they are alone.
* Might also think that "their" group's abilities are superior to those of other
Some under-confident / insecure people choose to belong to a strong-looking group,
as a way to feel more secure and confident.
=> It might explain the success of some cults or extremist political movements.
Group overconfidence sometimes leads to extremes of:
Arrogance, hubris, complacency and distrust of things / ideas / info
coming from the outside ("not invented here").
It results in irrational decisions or in neglect to take into account
Aversion to "strangers" (xenophobia, racism, parochialism...).
Overconfidence in management and in finance
Going to the business war with flowers and no helmet.
Overconfidence seems more common than under-confidence in many fields of life.
How many wars were started because of overconfidence!
This is notably the case in business and financial decisions.
Maybe entrepreneurs, managers and traders are specific species of warriors, even
And maybe it is a luck in some circumstances, as without their fighting instinct, things
would be at a standstill.
Another well known overconfidence effect is seen in project management,
as many projects needs much more money and time than originally planned.
In asset markets, overconfident investors / traders
(and also borrowers, corporate managers, advisers...)
tend to overestimate
Their information (knowledge illusion),
The accuracy of their estimates
Their abilities to win
(control illusion, experience illusion).
Inexperienced traders tend to be overconfident ...until the day when things turn bad.
In a lesser degree, about every trader thinks (s)he can beat the market.
This may induce him/her to take undue risks
and / or to overpay its prey and its victory (see winner's curse).
It is often a factor in overtrading (see that word), overconfident traders
have the idea that whatever moves they make, they will be the right ones.
Under-confidence (*), overconfidence and market sentiment
When the individual investor, or the market crowd, feels self-confident,
or on the contrary starts to wonder and to have doubts.
In financial matters, under- /over- confidence is about ones' own abilities to take
the right buy or sell decisions, not about market prospects.
For example, an investor can be pessimistic about the market
and confident in his/her own ability to take advantage of it.
But some social mood theorist link market rises and falls to waves of collective
over- and under-confidence that foster widespread and exaggerated hope or gloom.
That thesis is partly true as:
A random streak of luck in the market could fuel overconfidence (see self-
attribution) and lead to take more and more frequent, large and risky bets.
Obviously, no surprise here, overconfidence reaches more and
more people in bullish markets.
Well, about every investor feels lucky or smart then.
He thinks he will be able to find in time a less smart one, a "greater fool"
(see that phrase) to sell him the burning log.
This makes him keep his assets for too long, and to buy new ones, even when
that they got grossly overpriced.
This behavior sustains and develops price bubbles.
Also, any outside event that creates a "feel good" sentiment, even if it has nothing
to do with economy and finance, can boost confidence and self esteem.
(*) For underconfidence (which is the mirror sentiment of overconfidence and thus
is related to it as well in its causes as in its consequences) see the article on that phrase.
(*) To find those messages: reach that Behavioral-Finance group and, once there,
1) click "messages", 2) enter your query in "search archives".
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