It might give some confidence.
But our mirror might tell lies.
Overconfidence, under-confidence and other delusions about one's
capabilities, are behavioral biases based on false
beliefs about oneself (and to some extent about the external
They bring flawed decisions in many life situations, among
them when money is at stake, such as economics and finance
A) Overconfidence bias
I'm the best gun in town. The best poker player, too.
So how can I lose?
an excessive trust in his own
judgments, predictions and abilities.
This can reach even the most professionnal "experts" who
rely so much on their intuition brought by a long experience that they
tend to believe in their infallibilty in making previsions and miss some
Also successful businessmen / corporate executive might go
"a bridge too far", with a costly venture or merger that neglect the
base rate probability of success of such projects (actually a rate
that is quite low).
They think their past successes show them as more competent than
the small fry (forgetting they might just have been lucky).
They get overoptimist about the gain prospects of their moves
compared to the risks, costs and difficulties.
1) How to be overconfident...or preferably not.
But some people are more overconfident than others.
On the other hand some are naturally under confident (see C section).
An overconfident person tends to
- overestimate the chances of success of its actions (complacency),
- underestimate the risks (and perverse effects) of its decision.
* or from self-admiration
(and sometimes both!).
Optimism? Haste? Sometimes laziness?
Overconfidence is a biased self-centered anticipation that can cause:
- either over-optimism
while neglecting to explore all the pitfalls and drawbacks.
- or over-pessimism,
under one's own lofty "infallible" judgment, without exploring all its
But the opposite might sometimes occur:
inertia based on overoptimism and wild initiatives on over pessimism.
Same thing for overconfidence (you can be overconfident in your
judgment that things will turn bad) and under confidence.
Overconfidence can lead
* either to rush into wild actions, overtrading for example,
* or on the contrary to delay decisions about needed
Overconfidence can be
individual or collective, narcissist or dependent
=> Either an individual attitude.
For example, most car drivers consider their abilities as superior
to those of the other members of the motorized crowd.
This shows a human narcissistic tendency that makes many people think
they are a bit above other people.
Or at least feel (see below "group contamination") that they belong to a
group (elitism) with a superior behavior and/or vision.
People within a group (corporation, profession, organization, ethnic
group, community, country) tend to be more confident than
when they are alone.
They might also think that "their" group's abilities (and rights) are
superior to those of other groups.
Of course, union makes strength as a national motto says. But
group overconfidence sometimes leads to extremes of arrogance,
hubris, complacency and distrust of things / ideas / info coming from
the outside ("not invented here").
This neglects to take into account the external reality.
And also sometimes it breeds an aversion to "strangers" (xenophobia,
Some under-confident / insecure people (see below
"underconfidence") choose to belong to a strong-looking group.
It might sadly explain the success of some cults or extremist
A related phenomena is gullibility or dependence
created, not directly by a group, but by its leader or some
other person that take control of the decider (guru, expert,
On those phenomena see herd instinct and experts' power
4) Overconfidence in management and in financeOverconfidence is notably present in business and financial decisions.
Maybe it is a luck for the whole economy (well, except if
it leads to extreme exuberance that erase any precaution), as
without their fighting instinct, things would be at a standstill.
A well known overconfidence effect is seen in project management,
as many projects needs much more money, efforts, time than
Bad surprises are the rule, pals, we were naive to expect that the
world was on our side !
The case of the overconfident businessman or CEO, conditionned by
its own past successes that might just has been a matter of luck, was
In investing, under- /over-confidence is about ones' own abilities to
take the right buying or selling decisions, not about the direction
market prospects wille take.
For example, an investor can be pessimistic about the market and
confident in his/her own ability to take advantage of it, playing on
future, options or countercyclical assets.
Overconfident investors / traders (and also borrowers, corporate
managers, advisers...) overestimate their information (knowledge
illusion), the accuracy of their estimates and their abilities (control
illusion, experience illusion).
=> This may induce them to take undue risks and / or to overpay
their prey and victory (winner's curse).
It is often a factor in overtrading, under the idea by some
overconfident traders that most of the moves they make will be the
Collective aspectSome social mood theorists link market rises and falls to "waves" of
collective over- and under-confidence that foster exaggerated
optimism or pessimism.
This approach is partly true as a streak of luck, by following the
crowd could fuel overconfidence (see 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.
About every investor feels lucky or smart in such an exuberant situation.
He thinks he will be able to find in time a less smart one, a "greater fool"
to sell him the burning log.
This makes him keep his assets for too long, and even to buy new ones,
even when he is warned 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,
B) Self-delusions linked to overconfidence
(Genius inside)Now come the false beliefs about one's capacities.
They are found among most deciders, which means about anybody.
Those delusions show two sides:
- Illusion of competence, experience and knowledge,
- Illusion of control on outside events.
Origins of illusions
What is missing? What is too much?Those personal (or collective) illusions might have various origins,
(misunderstanding, flawed memory)
* or emotional
(attempt at compensating earlier pains
or following earlier pleasures).
Let us quote a few more precise ones.
- An imbalance, one way or the other,
and its practical experience.
They are usually both needed and each one reinforces the
When one side, either learning or practice, is too light, the
boat is in danger !
- Some mental laziness
or understand enough (see availability heuristic),
- A recent streak of prior successes.
A successful player can get a wrong feeling of infallibility
even if its successes come only from pure luck, or to the simple
fact that the economy became favorable to their venture or
the financial market was bullish and nearly everybody made
- Conversely, if things
turn bad, a trader might attribute it to bad luck.
mistakes and correct them in the future.
- Some ingrained or long developed narcissist tendency
all rights upon them and upon the world itself, the "master
of the universe" syndrome), as already mentioned.
- A belief that intuition or instinct is enough
- Magical thinking, illusion of control" (see article below).
Illusion is worse than ignoranceIs incompetence not enough?
Does illusion upgrade ordinary incompetence to perfect incompetence?
Ignorance, inexperience or incompetence are in themselves obstacles to
But illusions make it worse.
Things get graver when the decider believes he has no deficiency.
Normally, to know what we lack help us to find ways to compensate (*)
On the contrary, the illusive belief or feeling that we are fit paralyzes any
search to correct what is lacking to make a sound decision.
Same thing for competence, experience...
(*) Of course, when the lack of time or means cannot be compensated,
and to choose a course of actions is anyway needed, it might be better
to improvise a move than staying passive.
But with the provision that the decider knows its limitations.
Those self-illusions lead the player at the same time to underestimate
the difficulties of the situation and to overestimate its own abilities.
Those beliefs (or just a lack of conscious appraisal) are among the
ingredients of dangerous biases such as overconfidence (as detailed
in the above chapter), self admiration, narcissism and /or magical
Shared illusions (let us dream together)
societies also are prone to it and can easily become blind
People often find within groups an impression of strength, certainty
and safety against the outside world.
There might some reality in how groups are a support for individuals,
but it can be also only apparent and lead them to abandon some of
their personality and lucidity.
B+) Types of illusions
1) Illusion of competence, experience, knowledge
Mister Know it all.The (self-) illusion of competence, experience, knowledge is
a mental bias that makes people overestimate their ability and
This exaggerated reliance in their capabilities leads them to make
highly risky decisions.
2) Illusion of controlThe illusion of control is a conscious or unconscious belief close to
magical thinking and narcissism.
It makes people think / feel that things can only turn right for them,
that they were born under a good star, that luck is on their side and
the gods in their hands, that they have the mental capacity to
influence events and to run the show.
Maybe a way for them not to feel the anguish of uncertainty.
Like the illusion of competence it can lead to overly risky decisions
(for ex. in investment, to concentrate a big stake on only a few stocks).
Also, when the outcome is unfavorable, in can make neglect to analyze
why things went wrong so as to avoid the same mistakes, by attributing
the failure to an occasional luck reversal.
3) Anecdotal market example: the greater fool delusionGullibility, illusions and delusions are frequent in asset
markets, for example stock markets.
A typical one is the greater fool delusion
It is for an investor / trader to buy an extremely overpriced asset,
after a long price uptrend that lead to blatantly overpriced assets
compared to any rational valuation criterion, with the idea that
a greater fool will buy it later at an even higher price, before the
music stops and the price crashes down.
It might work, but that (extended) "trend following" tactic has also
a good chance to be found delusively that trader: the torrent of
greater fools might dry up very soon and the greater fool could
Afraid to be wrong and unable to choose between
the bucket of water or the bale of hay.
People might be under-confident in their possible
performance (compared to what they deem to be a good result).
Effects of underconfidence
When it freezes decisionUnderconfidence tends to make people, and among them investors,
freeze decisions (delaying tactics, status quo bias...).
Because of under-confidence, investors often procrastinate
when they face events that change the prospects.
They delay the needed action (buying, selling...).
This translates into an under-reaction in market prices.
Far from being immediate, price adjustments take place fully only
later and gradually.
Later overconfidence kicks in and investors rush to the new price
market momentums / trends,
which are the most striking market anomalies
When it leads to mimicry
In some cases, under-confidence makes investor easily influenced by
other people advices without checking by themselves if the advice is
sound or if they can be trusted.
Under-confidence can also be one of the factors that feeds the
It should not be confused with pessimism
As under / over confidence is about ones' own abilities,
it does not necessarily entail pessimism or optimism about market
prospects. You can be certain or uncertain that your pessimism
or optimism is right or wrong in the present market situation,
just choose your option ;-)
On the other hand, as said in the "overconfidence" section market rises
and falls are sometimes attributed to waves of collective over / under-
confidence, leading to general optimism or pessimism.
Here is a contribution of Jan Kenneth Sorensen in the Behavioral-finance group
that gives us a matrix that combines over / underconfidence with optimism /
1 Overconfidence and optimism
The classic popular notion of being in a boom. I think of a gold rush.
2. Overconfidence and pessimism
Being sure that conditions will only be worse and the good times are gone
My favorite example Ron Paul holding almost all of his wealth in gold.
Completely selling short would be another example; I have no doubt that some
people have done it and were wiped out by prosperity.
3. Underconfidence and optimism
Not too difficult to imagine.
In financial investing, better results than you expected are wonderful. But not
capitalizing on it (selling too soon or not investing in the first place) is very
In real investment, under investing in productive capacity (both physical
capital goods and infrastructure and intangibles such as R&D) would be
source of later shortage.
4. Underconfidence and pessimism
It is more difficult for me to imagine. I think it expresses itself in a desire for
Perhaps a flight to quality also reflects it, such as re allocating a portfolio to
blue chip stocks or bonds.