When traders are overconfident, they falsely believe that they can trade beyond their skill set. Overconfidence in trading usually reflects an exaggerated view of one's abilities, which can be fatal. Trading is an area in which accurate and realistic perceptions of one's skill levels are crucial.
It's interesting to observe that traders can be especially overconfident when they feel uncertain about their abilities. I know it sounds strange, but having trained and dealt with thousands of traders, I have found that often, when they feel inadequate, they tell themselves that they are superior so as to bolster their feelings of competence.
It's hard to escape this dynamic process of "ego defense." Everyone feels inadequate every now and then, and thinking, "I'm doing great" can soothe unpleasant feelings of incompetence. It's probably not a good idea to do this very often, but doing so from time to time is relatively harmless, and may even be a useful strategy when used sparingly in certain areas.
Telling yourself that you are a smart and brilliant trader has its time and place. It's fun occasionally, but if you do it too often, you may never look at your trading skills objectively and take the steps necessary to build the strengths you need to improve your trading. It is best to restrict such self-enhancing strategies to off-hours rather than during the trading day.
It's not useful to be overly optimistic and overconfident during the actual trading day, but during off hours, getting psyched up and feeling a little omnipotent can be helpful. During off hours, it can be used as an effective motivator, especially when you encounter a passing set of losing trades and feel unrealistically disappointed about your current circumstances. At these times, you may want to convince yourself that if you take specific action and trade from a plan, you can get yourself out of a minor rut.
Overconfidence is a big problem, however, when you overtrade and do so impulsively. The overconfident trader may put on trades that just won't pan out. Over time, a great deal of money is lost, and it is hard to get out of the hole. At these times, it is especially vital to take a brutal, honest look at your trading skills. You must gain an accurate assessment of your skills, identify your weaknesses, and build skills to compensate. Focus on performance rather than potential rewards to your ego and social status. Doing so will help you develop an accurate view of your skills and a realistic level of confidence. And if you have an accurate level of self-confidence, you will trade more profitably.
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