Overconfidence Trap: How Market Wins Can Cloud Your Judgement

Potential success in investing can feel particularly rewarding. When investments rise and decisions appear correct, our confidence as an investor grows. This confidence is natural, but when it turns into overconfidence, it can cloud judgement. In behavioural investing, this bias is called the overconfidence trap. Understanding how it works and finding ways to stay balanced can help investors avoid common mistakes and reduce unnecessary risks.

Table of contents

• What is overconfidence bias?
• How past success leads to risky decisions
• Consequences of the overconfidence trap in investing
• Some ways to stay grounded
• Practical self-check methods

What is overconfidence bias?

Overconfidence bias investing refers to a situation where an investor starts believing that their skills are stronger than they really are. After a few positive outcomes, they may feel like they “know” the market or can predict what will happen next. This belief can create comfort in taking decisions without any research or careful thought. Overconfidence is not about intelligence or knowledge. It’s a behavioural pattern where recent wins get the mind to believe that success will continue, whereas in reality, markets are unpredictable and returns are never guaranteed.

Read Also: Is overconfidence your biggest enemy in behavioural investing?

How past success leads to risky decisions

Past success can fuel overconfidence. A few examples* include:

• Belief in personal skill: Let’s say an investor buys a stock that goes up quickly. The gain may be due to luck or general market movement, but the investor attributes it to their own ability.
• Ignoring broader context: Success in a rising market may create the sense that one’s personal methods are responsible for the realised gains, while in reality most stocks are moving upwards.
• Desire to repeat wins: After one or two positive outcomes, investors may feel the urge to take bigger positions or to trade more often.

Such patterns can slowly lead to investor mistakes where decisions are based more on overconfidence than on careful analysis.

Examples for illustrative purposes only.

Consequences of the overconfidence trap in investing

The overconfidence trap can show up in many forms, often with hidden costs:

• Overtrading risks: Feeling certain about predictions may lead to frequent buying and selling. This can increase costs like brokerage, taxes, and reduce potential long-term gains.
• Concentration of money: An investor may put too much money into one stock or sector, believing strongly in their own choice. This increases risk if the outcome is different from expectations.
• Neglect of planning: Overconfidence bias investing often distracts from personal goals. Instead of sticking to a plan, investors may chase potential short-term opportunities.
• Emotional stress: When results go against expectations, disappointment can be intense, leading to frustration or rash moves.

These consequences show how investor psychology can create risks even when the market is moving favourably.

Some ways to stay grounded

Balancing confidence with caution is possible through simple habits:

• Acknowledge luck: Accepting that luck and timing also play a role in potential gains helps reduce the illusion of full control.
• Stay humble with success: Treat wins as temporary outcomes, not as proof of exceptional skill.
• Remember losses are possible: Keeping in mind that markets move both up and down and cannot be predicted can help create a balanced view.
• Follow a checklist: Having a set of conditions before making any investment can reduce the influence of sudden confidence.

These practices can provide a cushion against behavioural investing biases that cloud judgement.

Practical self-check methods

Small self-checks can help spot overconfidence early:

• Track decisions: Write down why a stock or fund was chosen. Later, compare the reasons with the actual result. This reveals if the realised success came from skill or external factors.
• Set limits: Set a maximum percentage of money to be placed in a single stock. This avoids concentration risks.
• Seek a second opinion: Talking to a trusted friend or adviser can highlight blind spots.
• Review trading frequency: If trades are happening very often without a clear plan, it may be a sign of overtrading.
• Pause after wins: Taking a short break before the next investment decision gives time for emotions to settle.

While these checks don’t guarantee results, they may reduce the chances of investors making decisions driven by overconfidence.

Read Also: The Psychology of Investing: What Drives these Patterns?

Conclusion

• Overconfidence bias investing happens when success makes investors believe that their skill is greater than it is.
• Past wins can fuel risky behaviour, such as ignoring context or chasing larger bets.
• Consequences include overtrading risks, lack of planning, emotional stress, etc.
• Staying grounded through limits and checklists helps balance confidence with caution.
• Practical self-checks like listing down reasons, reviewing frequency, and seeking a second opinion can protect against behavioural investing biases.

By noticing signs of overconfidence early, investors can make relatively steadier choices and reduce avoidable risks.

Past performance may or may not be sustained in future.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBe here.