Avoiding Overconfidence by Van K. Tharp, Ph.D. If I could give just one piece of advice to a trader, it would be: Avoid overconfidence—it could be your worst enemy. Thousands of traders make the mistake of becoming overconfident each month and lose substantial amounts of money. For example, the following incidents were brought to my attention just recently: A trader — whom we will call Henry — needed to make $7,000 each month to meet his living expenses. This particular month was exceptional; he made $20,000 in two weeks making low-risk trades and following his own trading rules. He was feeling on top of the world; he could do no wrong. One Friday morning, however, he noticed a marginal trade that involved more risk than he normally took. Henry decided to take it. The market immediately went against him and he was stopped out for a $1,500 loss. His money management rules called for a maximum risk of $1,000 on a trade, so his early morning results were totally unacceptable. As a result, he quickly opened up another high-risk marginal position. By the end of the day, he'd lost a total of $4,500. The following Monday he was still upset about losing $4,500. He took several more high-risk trades, only to lose another $3,500. A trader in the Midwest told me that he had made $80,000 in profits on a $40,000 account in two months of conservative trading. Then, he said, he stopped paying attention to risk — and blew out his total profit in two weeks. I visited a client in New York and spent some time talking to the firm's president about his trading. Indirectly, the company president mentioned how he was trading — he had most of his money tied up in large spread positions. I looked at what he was doing and told him that it could cost him his company. In response, he told me that he was totally protected — that it was a spread position with zero risk. Two months later, the firm lost $1.5 million from that position. The traders in each case were overconfident. The mental state of confidence has little to do with the accuracy of one's prediction about the market and even less to do with one's ability to make money in the market. Studies on confidence have shown that humans by nature are very inaccurate. But when people invest effort (or money) into a position, it is very difficult to admit being wrong. People tend to deceive themselves; self-deception occurs each time a person clings to a false belief. False beliefs that are rigidly held onto greatly increase the chance of failure, because people simply do not know what they are confronting. When people truly believe something, they manage to find evidence to support their belief. If someone expects the market to go up, then every correction upward in a bear market will support that theory. And if the market does turn around, even if the timing was off by six months, then such a person often will believe that he was correct all along. PERCEPTION VS. REALITY Psychologists Sarah Lichtenstein and Baruch Fischoff conducted studies that found that people who were taught to read stock charts and then asked to interpret another series of charts were correct only 47.2% of the time in predicting whether prices would be higher or lower one month later. Their confidence levels, however, averaged 65.4% (with 50% being chance confidence and 100% being certainty). The experimental subjects were no more correct when their confidence levels were high than when their confidence levels were low. When people invest effort (or money) into a position, it is very difficult to admit being wrong. What about extreme confidence—those times when we are really sure? Lichtenstein, Fischoff and their colleagues had subjects rate their confidence in various statements in termsof odds rather than a percentage. For example, 75% confidence would be equivalent to three to one odds, or being correct three out of four times. When the subjects gave odds of 100 to one in the confidence of their answers, they were correct only three out of four times in one study and four out of five times in another study. When subjects rated their confidence at a million to one, they were correct nine out of 10 times in one study and 16 out of 17 times in another study, even though the researchers carefully explained the meaning of the odds to those participating in the experiment. Moreover, most had enough faith in their confidence judgments to say they were willing to stake money on the validity of the statements. Most of us have a tendency to overestimate how right we are. This tendency does not depend upon intelligence. Einstein once wasted years of effort because he would not believe a colleague who apprised him of an error in his calculations. Nor does overconfidence in our positions depend upon our expertise in a given subject. Experts may be more knowledgeable about their subject matter than others are, but they are still not very accurate in estimating how much they know. Expertise in technical analysis, for example, has little to do with making money in the markets. AVOIDING THE OVERCONFIDENCE BIAS The only factor that does seem to influence overconfidence is the amount of information that is available; the more information to which one is exposed, the more one tends to be overconfident about his or her beliefs and positions. Thus, if you are exposed to a great deal of information in order to make a decision about the market, you will be more adamant about your position once you make up your mind. Unfortunately, most information — especially financial information — has little correlation with price movements. Thus, exposure to a lot of data will probably make a trader much more confident in a position but have little bearing on whether he is correct about the direction of market movement. Overconfidence can be avoided if you keep in mind a simple set of guidelines: Being right has little to do with making profits. A good hitter in baseball will make outs 70% of the time and hit home runs about 3% of the time and will have what is considered to be an excellent average. If he improved his results to consistently making outs only 60% of the time and hitting home runs 5% of the time, he would probably be one of the best hitters ever. The same generally holds for most good traders. They make winning trades less than 50% of the time and they hit home runs occasionally. If their losses are small, then profits can be tremendous. Successful trading requires that you know when you are wrong. Before you enter the market, always know what signs the market will give you to prove you are wrong. If you don't know when you are wrong before you get in a trade, then you do not have a workable trading method. Make sure you have a set of rules that you use to guide your behavior. These rules should include information about how you will know when you are wrong and the necessary steps you must take to get out. In addition, the set of rules should also fully detail the conditions under which you will open a position and take profits. Trade only when you meet all the conditions that you set forth in your rules. A mistake means not following your rules. You can make money and still make a mistake by violating your rules. This combination is particularly dangerous because it encourages the trader to repeat those mistakes. In contrast, you may do everything perfectly, according to your rules, get out when the market tells you you are wrong, and lose money. This is a normal part of trading and occurs frequently. Pat yourself on the back for following your rules. If you cannot follow these four guidelines, then the problem may be much deeper than just overconfidence. You may have a problem with internal conflict or self-esteem. If you think you have such problems, no trading methodology will help you. Instead, get some professional help. Such problems will invariably affect your wealth, your relationships and your happiness. I welcome input from STOCKS & COMMODITIES readers. What issues would you like me to address? Send in your questions to me care of STOCKS & COMMODITIES, 3517 SW Alaska Street, Seattle, WA 98126, and I'll discuss them here. Let us hear from you. Van K. Tharp is a research psychologist who specializes in the psychology of top trading. Investment Psychology Consulting, 337 Lochside Drive, Cary, NC 27511, (919) 233-8855. -- 波段單王道：多頭做多、空頭做空、盤整少做、賺錢加碼、賠錢停損 小弟在永豐金證券，來開戶就不定期提供個人觀察潛力股名單 以及操作建議，股票期權手續費都有優惠唷，意者請mail ^^ http://blog.pixnet.net/stasis --

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