The Illusion of Control: Why Investors Misjudge Risks in a Volatile Market

Many people enter the stock market believing that they are in full control of their investments. Unfortunately, markets don’t always move the way we expect. Even experienced investors encounter losses when they believe they know more than they really do. This false sense of control is the illusion of control, and it explains why many investors lose money.

Let’s understand why overconfidence in trading takes over, and some easy ways to manage risk better.

• Table of contents

• Why we think we can control investment outcomes
• How overconfidence affects investing
• Tips to manage risk better

Why we think we can control investment outcomes

The stock market is unpredictable. Prices move for many reasons, such as company performance, global news, interest rates, and investor sentiment. Despite that, many investors believe they can guess what’s coming next. This is why:

• We remember our wins more than our losses: If a stock we picked goes up, we feel smart. If it goes down, we often blame the market or someone else. Over time, this gives us a false idea of how good we really are at investing.
• We trust patterns too easily: Humans love to see patterns. When we see a stock go up for a few days, we expect it to continue. However, markets don’t follow neat patterns, and past performance doesn’t promise future results.
• We rely only on news or tips: Following the news or social media gives us a feeling of control. However, the market reacts to many unseen forces, and just having information doesn't mean we can control potential outcomes.

This illusion makes us think we can time the market or always pick winners. This rarely happens in real life, and it is one big reason why investors lose money.

Read Also: Can Mutual Funds Protect Against Stock Market Volatility?

How overconfidence affects investing

Feeling confident is good, but overconfidence in trading can lead to poor decisions. Some signs to help you recognise overconfidence:

• Taking big bets on a single stock: Believing one stock will give huge potential returns often leads people to invest too much in it, without considering what could go wrong.
• Trading too often: Many investors believe they can “time the market” i.e. buying low and selling high. But frequent trading increases costs and can result in losses.
• Ignoring warnings or advice: Overconfident investors often stop listening to others. They trust their own judgement too much and avoid feedback.
• Chasing quick profits: Greed and confidence together can lead to risky moves. Investors may enter trades based on tips or hype, hoping for quick potential gains. This behaviour often increases stock market risk vs. reward imbalance.

Overconfidence can blind us, making us believe we’re managing risk, when we’re actually increasing it!

Tips to manage risk better

One cannot completely avoid risk in investing, but it can be managed in the following ways:

1. Set clear goals: Know why you're investing. Are you saving for retirement or for buying a home? Goals give you a clear direction and help you choose a suitable level of risk.
2. Diversify your portfolio: Spread your money across different stocks, sectors, and asset types like mutual funds or fixed deposits. This way, if one investment does badly, others can balance it out.
3. Don’t invest based on emotions: Markets often go up and down. Fear and greed can push you to buy or sell at the wrong time. Avoid making hasty decisions based on short-term movements.
4. Understand what you are buying: Don’t invest in something just because others are. Learn about the company or fund and the risks involved before investing.
5. Review, but don’t react too quickly: It’s good to check your investments every few months. But, avoid changing your plan every time the market moves. Focus on your long-term goal.
6. Be realistic about returns: Everyone desires high returns, but they come with higher risk. Understand the stock market risk vs. reward balance and choose what suits your comfort level.

Read Also: SIP in Flexi Cap Fund: Tackle Volatility Smartly

Conclusion

The market is full of ups and downs, and nobody can predict it all the time. Believing you can control everything leads to overconfidence, which causes investors to lose money.

By making informed choices and following a steady plan, you can improve your investing approach. If you want to know how to manage investment risk, remember that it starts with knowing yourself better than the market.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

The content herein has been prepared on the basis of publicly available information believed to be reliable. However, Bajaj Finserv Asset Management Ltd. does not guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed.The tax information (if any) in this article is based on current laws and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.