Stock market bubbles exist when stocks are overvalued but can be difficult to truly measure as” value” is a subjective metric. Bubbles are easily seen in hindsight as the warning signs that may have suggested the bubble tend to glare; this is known as hindsight bias. However, the issue I have with hindsight bias is that it encourages a view of the bubble as being more predictable than it really was.
As an example, one needs to look no further than the sub-prime mortgage mess we are still dealing with today. Yeah, it seems obvious now to look back and see the proverbial writing on the wall, but why wasn’t it so easy to see back then? Don’t know and don’t care as that’s not what this post is about.
This post is about the bubbles that we can create in our own trading. I’m referring to the overconfidence that many experience at some point in a trading career. Don’t get me wrong, confidence is needed in yourself, your system, and the market as a whole in order for trading to work. However, overconfidence in any of these areas can lead to low probable trading as overtrading occurs. It’s easy to become overconfident after a string of wins and many traders fall victim, especially males.
Researchers Barber and Odean looked at 35,000 trading accounts over a period of six years to see if overconfident investors trade excessively. The results should not be too surprising, but this is what they found. Single men trade 67 percent more than single women. In addition, this overtrading reduced the male’s returns by 1.44 percentage points per year more than the single women.
Bottom line is that overconfidence can lead to overtrading which leads to diminished returns, regardless of gender. A lack of preparation can often be blamed for the overconfidence as one “trades from the hip” versus planning and preparing for each day. Trading is a difficult and like any other business it demands hard work (effort) on the participant’s part. Despite what the “gurus” tell you, it’s not that easy to make it as a trader; it’s not impossible either.
Trading is no different than anything else in life in that you get out of it what you put into it. That doesn’t mean that if you dive into everything trading and start reading books, posts, tweets, etc. that you’ll be successful. There has to be a method to your research, a pattern if you will. Look at what others do, ask questions, and form your own routine and give it a test drive.