Internet encourages overconfidence in share trading
Stuart Wilson May 02, 2006
THE share market has been powering forward for some time now, giving many novice investors - and some experienced ones too - serious overconfidence problems.
One of the biggest mistakes you can make as an investor is thinking that your wonderful investment strategy is responsible for great returns, when your portfolio has merely benefited from a buoyant market.
The ability to buy and sell shares over the internet has also been shown to produce overconfidence.
This recent phenomenon is most prevalent when investors initially switch to online trading. Their overconfidence is helped along because they suddenly have access to a wealth of information on the market, the economy and individual companies, making them feel better informed than ever before.
Online trading also gives investors better access to transactions. The process is much simpler than calling your stock broker and it is usually both cheaper and faster.
This leads to a greater number of trades, the cost of which is often ignored by punters.
Perhaps it is not surprising that men show a much greater tendency towards overconfidence than women.
Men trade 45 per cent more often than women when online and their returns lag females' returns by about 1 per cent a year.
There are many teams of very intelligent, market-savvy, hard working and well-connected analysts making investment recommendations every day. Why is it then that so many part-time investors who are not in the investment industry and have no access to management think they can get better results by relying on their own judgment?
Here we see another facet of overconfidence - rationalisation. Some retail investors discount the views of the professionals - especially when it disagrees with their own opinion - and point to brokers' conflicts of interest.
Another common psychological trap that feeds overconfidence is called the "false consensus effect".
This is where you think that your point of view is shared by the majority of people, and can result in flawed investments decisions, and again, overconfidence.
For example, ask yourself if Telstra is a "buy" or "sell" at the moment. Now ask yourself what percentage of people would agree with you.
Irrespective of your view on Telstra, it is probable that you have overestimated the number of people who think you are right.
It is important to realise that just because you have access to more information it doesn't mean that you have read it. If you have read it, that doesn't mean you understand it. If you understand it, that doesn't mean you have correctly interpreted it.
The fact is, overconfidence increases in line with the difficulty of the task, making investing in shares a prime candidate.
This whole area of investing psychology, known as behavioral finance, is perhaps the most overlooked subject in investment education. Because it affects both the novice and experienced investor, it would serve shareholders well to better understand overconfidence, how to identify it and how to control it.
Stuart Wilson is chief executive of the Australian Shareholders Association Ltd