Optimism and Overconfidence

Behavioral Finance

A bias towards optimism often leads investors to have an unrealistically positive view of themselves and their futures. The psychological biases of investors that are prone to overconfidence is perhaps the most damaging because our faith in our judgements usually exceeds their accuracy.

Such overconfidence is something investors must guard against. That is not easy because overconfidence is fueled by related psychological biases, called optimism, the illusion of knowledge and the distortion of hindsight. 

Optimism biases lead many individual investors to overestimate their investment results. Our optimistic nature is augmented by other factors that boost our confidence. It is our tendency to believe that the accuracy of our forecasts increases with more information.

The reason for overtrading is that investors feel motivated to master the environment. This is the illusion of control, the tendency to overestimate our ability to influence trajectories over which we have little control. Overconfidence is always problematic in bull markets, since the shares during this period show sustained stability. Our confidence takes hold, making us believe that the prevailing conditions will persist.

The wise investor not only knows how to recognize signs of overconfidence in him but also knows how to apply the brakes when the signs become visible. Overconfident investors tend to chase returns and underestimate risk.

Aiyan Thiruvalluvar says

நுனிக்கொம்பர் ஏறினார் அஃதிறந் தூக்கின்

உயிர்க்கிறுதி ஆகி விடும். (476)

चढ़ा उच्चतम डाल पर, फिर भी जोश अनंत ।
करके यदि आगे बढ़े, होगा जीवन-अंत ॥ (४७६)

Explanation by Scholars: 

There will be an end to the life of him who, having climbed out to the end of a branch, ventures to go further.

தன்னைப் பற்றி அதிகமாகக் கணக்குப் போட்டுக் கொண்டு, எல்லை மீறிப் போகிற ஒருவர், நுனிக் கிளையில் ஏறியவர் அதற்கு மேலும் ஏறிட முயற்சி செய்தால் என்ன ஆவாரோ அந்தக் கதிக்கு ஆளாவார்.