T2W Trading Community

Overconfidence

Overconfidence is a particular kind of trap that springs shut when people have or think they have special information or personal experience, no matter how limited.  That's why small traders get hurt trading on no more information than “hot-tips.”

Tim is a farmer.  He raises hogs and purchases huge amounts of feed to provide for his hogs.  Tim has a large farming operation which is quite profitable.  He takes 250 hogs a week to market. Because of a steady flow of hogs from his operation to the market, Tim has no need to hedge his hog business because he is able to dollar average the prices he gets for them.  But Tim does want to indirectly reduce the cost of the feed he has to buy, so he purchases soy meal futures.  Tim listens to weather and farm reports all day long.  He attends meetings of other farmers, and tries to gather all the information he can that might help him be more profitable.  But Tim has a major problem, called tunnel vision.  When he looks out at the grain fields in the area where he lives, whatever he sees there he extrapolates to the whole world. 

In other words, if Tim sees that the surrounding fields are dry, he suspects that all fields everywhere must also be dry.  One year Tim witnessed a local drought.  He checked with all the local farmers and they said they were truly experiencing drought conditions.  He looked at the news on his data feed, and sure enough it said that there was a drought in his area.  In fact, the entire state where Tim raises his hogs was undergoing drought. 

Tim wasn’t too concerned about his own feed bins.  He had plenty of it in his silos from previous bumper crop years.  Tim decided to be piggish and speculate on what he considered to be inside information.  He called his broker and bought heavily into soy meal futures.  Tim was confident.  He was sure that soy meal prices would explode upward some time soon, and that he was going to make himself a small fortune.  Tim's greed may have turned him into a hog.  However, the futures he purchased started moving down and the value of his investment began to shrink markedly.  What Tim failed to do was to have a broader perspective.  Everywhere else that grains were grown, farmers were experiencing rain in due season.  The drought was localized almost entirely within the state in which Tim did his hog raising.  Tim lost because he was confident in the limited knowledge he had.

What should be done?  

We all need to broaden our horizons.  We need a humble attitude relative to the markets.  We can never afford to wallow in overconfidence in what we perceive as special knowledge.  A trader can never afford to let his guard down.  Tim thought he knew something that others hadn’t yet caught onto.  In so doing, Tim  made another mistake as well.  He heard only what he wanted to hear.

Hearing What You Want to Hear – Seeing What You Want to See

Marketers call this preferential bias.  Preferential bias exists among traders.  Once they develop a preference for a trade, they often distort additional information to support their view.  This is why an otherwise conscientious trader may choose to ignore what the market is really doing.  We've seen traders convince themselves that a market was going up when, in fact, it was in an established downtrend.  We’ve seen traders poll their friends and brokers until they obtained an opinion that agreed with their own, and then enter a trade based upon that opinion.

A student of ours, Fran and her husband, John, decided they wanted to go to live in the Missouri Ozarks.  Everyone told them that there was no way for them to make a living there.

Everyone they asked advised them not to do it.

Finally, a minister in the Church they proposed to attend told them that they were to serve there. Out of twenty or thirty people they asked, that minister was the only one who told them to come.  Of course, it was exactly what they wanted to hear. They sold their home and most of their possessions accumulated over a lifetime.  They moved to the Ozarks and went broke within a year.  They had to leave and begin all over again.  John, who had been semi-retired, now had to find a job.  So did Fran.  She had to give up a promising start as a trader to go out to put food on the table.

What should be done? 

Look at each trade objectively.  Do not allow yourself to become married to your opinion.  Learn to recognize the difference between what you see, what you feel, and what you think.  Then, throw out what you think.  Lock out the input of others once you have made up your mind.  Don't let your broker tell you what you want to hear.  Never ask your broker, your friends, or your relatives for an opinion.  Turn off your TV or radio, you don't need to see or hear what they have to say.  Take all indicators off your chart and just look at the price bars.  If you still see a trade there, then go for it.