Confidence Kills your Bank Account
January 23rd 2020 | 5 minute read
We know that our brains have superior pattern recognition. One pattern I recognized outside of the charts was a pattern of "I'm on top of the world. Look how great I am. Now let's trade". BOOM!. I lose a great deal of money. I have done this so many times in my rookie days. Maddening. Embarrassingly, I had a very bad day where it could have been a small draw down day. So, what happened?
A recent book I am reading, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, by Jason Zweig, helped me discover what is going on. There is an entire chapter on Confidence. I learned, our brains play with us. Not always in a great way. For men, we look in the mirror and see a perfect Mr. Universe body where there is none. Or for women, the mirror reflects a beautiful model. This vision is called "positive illusions" This is how we are built for good reasons. Positive thinking and overconfidence keeps capitalism alive. Extreme overconfidence is dangerous. We need some confidence or we would never leave the cave to hunt for our food. We would never place a buy/sell order with out confidence. My blog title is a lure because we know we need confidence. The true title is "Overconfidence Kills your Bank Account".
An interesting study found that people are more confident of an outcome when they place money on it. Meaning, if asked, heads or tails, you would not be as sure about the outcome. But if you put money on the outcome, you are more confident. Of course the results are the same. Your wager has no affect on the coin toss. Your mind however gave you a boost of feel good. When we buy stock we have more expectation on direction. When the direction goes against us we then believe we can not possibly be wrong and let the trade bleed us dry. Do you want to make money or do you want to be right?
Once on a roll, nothing can stop you. Your expectations are on autopilot. You hear "there is more where that came from". Another experiment was conducted where some people won huge gains playing a game. The study would then change the rules of the game without the participants knowing they changed. The people who won the larger amounts, could not process that the game had changed. Hmmn, sounding a bit familiar? Monetary gains have narcotic power. This is bad.
Being over confident built from a hot streak brews a perfect storm. You are no longer taking grade A setups. You look at the charts through rose colored glasses. Now, everything looks like a great setup. Suddenly your account is shrinking. Denial sets in because you cannot fathom you are wrong. Finally, you are exhausted because you have been beaten with a humility club. You believe, I am not built for trading. A complete manic reversal.
My coaching psychologist said, "Become Aware of the problem, understand it, change your perspective". We are aware that our bank account is drawn down more than our past winnings. We understand extreme confidence is the culprit. To change our perspective, we can ask ourselves, what don't we know about this next buy/sell? What don't we know about the market? This thought is different from "Nothing can go wrong because I am on a winning streak" Humility club, where are you?
Recognize the OVERconfidence trigger and put it back in place immediately. You will be thankful later. Acknowledge you have done well lately but this has no bearing on the future. Stay steady on the course. The road to trading hell is paved with overconfidence
Warren Buffett "What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things as long as he or she avoids big mistakes."