Explainer · Trading Psychology
Overconfidence: the bias that makes people trade too much
Most people who start trading believe they know a little more than they do. Research on real brokerage accounts shows what that belief costs: more trades, more fees and lower results.
Quick answer
Overconfidence bias means believing your knowledge is more precise than it is [1]. In brokerage data, overconfidence helps explain why individual investors trade too much and earn less: households that traded most earned 11.4% a year while the market returned 17.9% [2].
Key points
- Overconfident investors believe the precision of their knowledge is greater than it actually is [1].
- In a 2024 US survey, 56% of investors rated their own knowledge highly, while the average quiz score was 5.3 out of 11 [4].
- Among 66,465 US households, those that traded most earned 11.4% a year against 17.9% for the market [2].
- Many people cannot say what their own past returns were, which makes it hard to learn from them [5].
- Fixed risk per trade and written records are the practical checks a beginner can use.
On this page
What is overconfidence bias?#
Brad Barber and Terrance Odean, two finance researchers who studied tens of thousands of brokerage accounts, define overconfident investors as people who believe the precision of their knowledge about the value of a security is greater than it actually is [1]. It is not the same as arrogance. You can be modest in person and still feel more certain about a trade than the evidence supports.
The prediction that follows is simple. If you think your information is better than it is, you will act on it more often. Theoretical models predict that overconfident investors trade excessively [1], and the brokerage data below tests that prediction.
How confident are investors compared with what they know?#
The FINRA Investor Education Foundation's 2024 survey of US investors offers a recent snapshot. It covered 2,861 people who hold investments outside retirement accounts [4]. A majority rated their own investment knowledge highly. On an 11-question quiz about investing, the average respondent answered 5.3 questions correctly [4], or about 48% (calculated).
The report itself concludes that investors continue to have positively biased perceptions of their own knowledge [4]. These are two separate statistics, so they do not show that the same people rated themselves highly and scored low. A third figure is more direct: among investors who feel highly knowledgeable, 51% could not identify the warning signs of fraud, which the report says suggests overconfidence can put investors at risk [4].
Does trading more lead to lower returns?#
In the best-known test, Barber and Odean followed 66,465 households with accounts at a large US discount broker from 1991 to 1996 [2]. The average household turned over more than 75% of its stock portfolio each year [2]. The households that traded most did worst. After costs, frequent traders earned 11.4% a year, while households that traded infrequently earned 18.5% and the market returned 17.9% [2].
Costs are a large part of the gap. In that period, the average round-trip trade above $1,000 cost about 3% in commissions and 1% in bid-ask spread [2]. Commissions are different today, so do not read those figures as current prices. The mechanism still holds: every round trip has a cost, and more round trips mean more of it. Our guide trading fees explained covers what you pay now.
| Group | Net annual return |
|---|---|
| Households that traded most | 11.4% |
| The market | 17.9% |
| Households that traded least | 18.5% |
Barber and Odean (2000) [2]. Returns are group averages after trading costs. Past returns from the 1990s are not a guide to future results.
The authors' explanation is overconfidence. In their words, overconfidence can explain high trading levels and the resulting poor performance of individual investors, and their central message is that trading is hazardous to your wealth [2]. The averages hide a wide spread of results, so this does not mean every active trader did badly.
What did the study of men and women find?#
Psychology research has found that men tend to be more overconfident than women in financial matters, so Barber and Odean used gender as a test: if overconfidence drives trading, men should trade more and lose more to it [1]. Using over 35,000 households at a large discount brokerage from February 1991 to January 1997, they found exactly that [1].
The point is not that one group is better at picking stocks. The study measured the cost of trading, and the group that traded more paid more for it.
| Group | Trading compared with women | Net return lost to trading each year |
|---|---|---|
| Men | 45% more | 2.65 percentage points |
| Women | Baseline | 1.72 percentage points |
Barber and Odean (2001) [1]. The difference in return lost is 0.93 percentage points a year (calculated).
Why do losing traders keep trading?#
If trading too much is costly, why don't people notice and stop? One reason is that they do not know their own results. Markus Glaser and Martin Weber compared 215 online broker investors' estimates of their past returns with their actual portfolios and found that investors are hardly able to give a correct estimate [5]. Inexperienced investors could not give a reasonable self-assessment at all, which the authors say impedes their ability to learn [5].
A larger study of day traders on the Taiwan Stock Exchange from 1992 to 2006 points the same way. The aggregate performance of day traders was negative, and 74% of day-trading volume came from traders with a history of losses [3]. Previously unprofitable traders with 50 or more days of experience had a 95.3% probability of day trading again within the next 12 months [3]. The authors say these results fit models of overconfidence and biased learning rather than rational learning [3]. The full picture is in do most day traders lose money.
How can you check your own confidence?#
You cannot feel your way out of overconfidence, because the bias is in the feeling. You can, however, compare what you expected with what happened. None of the studies above tests these habits, so treat them as practical checks, not proven cures.
- Write the forecast before the trade
Note what you expect to happen, by when, and how sure you are. A vague idea cannot be checked later.
- Write down every cost
Spread, commission and any financing. Frequent trading made costs a large drag in the brokerage data [2].
- Keep the risk per trade fixed
Use position sizing so that feeling sure never means risking more.
- Compare after a batch of trades
After a set number of closed trades, total the real result from your records, not from memory. A trading journal makes this possible.
- Compare with doing nothing
Ask how your result compares with simply holding a broad market investment over the same period, after your costs.
Mistakes beginners make with overconfidence#
- Reading a winning streak as skill
A few good trades in a row can happen by chance. Judge skill over many trades and after costs, not over a lucky week.
- Judging results from memory
Research found investors are hardly able to estimate their own past returns [5]. If it is not written down, you do not know it.
- Ignoring the cost of each trade
A trade that looks free still carries a spread. More trades mean more costs, whatever your hit rate.
- Feeling ready because you studied
Knowing the terms is not the same as being able to spot a bad deal. In the FINRA Foundation survey, 51% of investors who felt highly knowledgeable missed the warning signs of fraud [4].
Frequently asked questions#
Is confidence bad for a trader?
Do people who trade more make more money?
In the US brokerage data we cite, no. The households that traded most earned 11.4% a year net, against 18.5% for those that traded least [2]. These are 1990s averages, not a rule for every trader.
How do I know if I am overconfident?
Write down your forecast and your confidence before each trade, then compare them with the recorded results after a batch of trades. Most people cannot judge their own past returns from memory [5].
Does experience cure overconfidence?
Not by itself. Glaser and Weber found that experience reduced simple maths errors in estimating returns but did not seem to change the behavioural mistakes [5].
The bottom line#
Overconfidence feels like knowledge, which is why it is hard to see from the inside. The brokerage data is clear about the pattern: people who trade the most pay the most in costs and, on average, end up with less. Keep your risk per trade fixed however sure you feel, write down what you expect before each trade, and judge yourself on recorded results after costs. Use only money you can afford to lose, and read the risk disclosure before trading anything with leverage.
Sources
- Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment" (Brad M. Barber and Terrance Odean), The Quarterly Journal of Economics, February 2001.
- Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors" (Brad M. Barber and Terrance Odean), The Journal of Finance, Vol. LV, No. 2, April 2000.
- Learning, Fast or Slow" (Brad M. Barber, Yi-Tsung Lee, Yu-Jane Liu, Terrance Odean, Ke Zhang), The Review of Asset Pricing Studies, Vol. 10, No. 1, pp. 61 - 93.
- Investors in the United States: A Report of the National Financial Capability Study" (2024 Investor Survey).
- Why inexperienced investors do not learn: They do not know their past portfolio performance" (Markus Glaser and Martin Weber) - RePEc record of SFB 504 working paper 07-70; published in Finance Research Letters, vol. 4(4), pages 203-216 (2007).
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