Overconfidence – 2

The Illusion of Validity

Subjective confidence in a judgment is not a reasoned evaluation of the probability that this judgment is correct. Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it. It is wise to take admissions of uncertainty seriously, but declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true.

Business – When the business personal preparing blueprint for a particular project and the narrative of the project seems good then he starts believing that this project is very good. Thus, they have to execute that project. But this confidence can turn out as overconfidence.

Investment – When we study a particular company and its narrative looks so good then we start getting confidence in the future performance of the company. But this confidence has created a story in our mind and that does not necessarily to be proven as true so that we also should work on writing down what can kill this idea. This helps us to make wise and rational decision.

The Illusion of Stock-Picking Skill

What made one person buy and the other sell? What did the sellers think they knew that the buyers did not?

Buyers think the price will increase and sellers think that price will fall.

Individual investors try to react to each news but institutions are selected about the reaction on the news which also proves their label of Smart money.

The majority of people have an illusion of skills. The majority of people believes that picking stocks and getting a return on them is mostly responsible for their skills and does not appreciate the role of luck.

But it is not the ultimate truth. There is a role of luck that should be appreciated. Not believing the role of luck will lead to overconfidence in their skill. And that will tend to make any irrational decision. So that after buying or selling, we will think that stock price will move as per our expectation because we have completed with all necessary study and confident about movement.  

We should always think that the seller/buyer has much more insights than us which make him selling/buying a particular stock. This thought process helps us with widening our thoughts process.

This entire series will be review with various examples from books which are Thinking, Fast and Slow and The Art of Thinking Clearly.

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