Overconfidence bias is an over-inflated belief in one’s skills as a trader. Traders may believe that their knowledge of trading is complete and have nothing further to learn. This is detrimental to one’s earning capabilities on the market.
Risks of Overconfidence
Overconfident traders tend to get themselves into losses by trading too frequently or by placing extremely large trades as they try for a large profit. Inevitably, an overconfident trader will keep entering and exiting trades or risking too much on one trade that may result badly and heavily impact their account.
Overcoming Overconfidence
A good way overcome overconfidence is to put in place strict risk-management rules. These rules should at least limit the number of markets one is investing in, and the number of stocks that are being traded at one time. Traders should also note how much of their account they are willing to risk on any one trade, and how much of the account they are willing to lose before they take a break from trading and re-evaluate the trading strategy.
By limiting the number of trades that an individual is willing to make and the amount of risk he or she is willing to take, risk can be spread out evenly over the entire portfolio.
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