3 . Overconfidence
Many successful people reject the possibility of luck or randomness having any effect on the outcome of an event , whether a career , an athletic contest , or investment . E . B . White , author of Charlotte ’ s Web and a longtime columnist for The New Yorker , once wrote , “ Luck is not something you can mention in the presence of a self-made man .” According to Pew Research , Americans especially reject the idea that forces outside of one ’ s control ( luck ) determine one ’ s success . However , this hubris about being self-made can lead to overconfidence in one ’ s decisions , carelessness , and assumption of unnecessary risks .
In October 2013 , Tweeter Home Entertainment Group , a consumer electronics company that went bankrupt in 2007 , had a stock price increase of more than 1,000 %. Share volume was so heavy that FINRA halted trading in the stock . According to CNBC , the reason behind the increase was confusion about Tweeter ’ s stock symbol ( TWTRQ ) and the stock symbol for the initial offering of Twitter ( TWTR ).
J . J . Kinahan , chief strategist at TD Ameritrade , stated in Forbes , “ It ’ s a perfect example of people not doing any homework whatsoever . Investing can be challenging , so don ’ t put yourself behind the eight-ball to start .” Even a cursory investigation would have informed potential investors that Twitter was not publicly traded , having its IPO a month later .
Stock market success is the result of analysis and logic , not emotions . Overconfidence can lead to any of the following :
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Failure to Recognize Your Biases . Everybody has them , according to CFP Hugh Anderson . Being biased can lead you to follow the herd and give preference to information that confirms your existing viewpoint . Too Much Concentration in a Single Stock or Industry . Being sure you are right can lead to putting all your eggs in a single basket without recognizing the possibility that volatility is always present , especially in the short term . Excessive Leverage . The combination of greed and certainty that your investing decision is right leads to borrowing or trading on margin to maximize your profits . While leverage increases upside potential , it also increases the impact of adverse price movement . Being on the Sidelines . Those who feel the most comfortable in their financial capabilities often believe that they can time the market , picking the optimum times to buy , sell , or be out of the market . However , this can mean you will be out of the market when a major market move occurs . According to the DALBAR 2016 Quantitative Analysis of Investor Behavior , the average investor – moving in and out of the market – has earned almost half of what they would have made for the last 15 years if they had matched the performance of the S & P 500 . J . P . Morgan ’ s Roy notes that if an investor had been out of the market just the 10 best days over the past 20 tears – a span of 7,300 days – the return would be slashed in half .
Strategies to Stay Grounded Strategies to reduce the impact of overconfidence include :
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Spread Your Risk . While not a guarantee against loss , diversification protects against losing everything at once . Jim Cramer of TV ’ s Mad Money recommends a minimum of 10 stocks and a maximum of 15 in a portfolio . Less than 10 is too much concentration , and more than 15 is too difficult for the average investor to follow . Cramer also recommends investing in five different industries or sectors . Investors should note that one benefit of mutual funds and ETFs is automatic diversification .
Buy and Hold . Warren Buffett is perhaps the most famous and ardent proponent of the buy and hold strategy today . In a 2016 interview with CNBC ’ s On the Money , Buffett advised , “ The money is made in investments by investing , and by owning good companies for long periods of time . If they [ investors ] buy good companies , buy them over time , they ’ re going to do fine 10 , 20 , 30 years from now .”
Avoid Borrowing . Leverage is when you borrow money to invest . And while leverage can magnify profits , it can also amplifies losses . It increases the psychological pressure to sell stock positions during