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I enclose a post from Dr Tharps blog on overconfidence this is a well documented behavioral finance phenomenon.
The point I wish to raise is that I saw a classic case of information over confidence yesterday. The guys in our office attended a presentation with a major money manager in our sector and the guys picked up some market intellegence that the money manager had a new R1 billion to spend which is a sizeable slug of our sector R65b.
Straight away the guys were filled with a sense of over confidence with the information they now had at their disposal. Now I know I am a contrarian, but can you imagine the shock when the market behaves to the contrary of what is expected from spending this new money.
How can it happen?
Firstly, there is a good chance that the information is not "new" or only been for their ears, secondly the market has been running up in the last week, which is perhaps the market anticipating the spending and therefore ala the efficient market it is adjusting accordingly.
Lastly, it is also possible that the new R1b is making up for withdrawls from other investors into the sector, which anecdotally is quite possible as the recent sell-off spooked quite a few retail investors.
So in essence one always needs to do their homework and then once it is done one needs to appreciate that there could always be another answer.
The Problem with Overconfidence
Most of us have a tendency to overestimate how right we are. This tendency does not depend upon intelligence. 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.
The more information to which one is exposed, the more one tends to be overconfident about his or her 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 the market movement.
