Fear is addressed many times in trading. But many do not think about the opposite of fear – overconfidence, and how it can cause just as many problems as fear. Just like fear is amplified in the crypto space due to dramatic losses, the effects of overconfidence are amplified with 1,000% profits.
Overconfidence in Life
David H. Freedman provides a great example of generalized overconfidence in life, as seen in driving:
“People tend to overestimate their skills behind the wheel and underestimate the skills of the boobs and psychopaths driving around them, a phenomenon that psychologists call “optimism bias” and the rest of us simply call delusional overconfidence.”
Freedman’s quote is a great everyday example of overconfidence. Overconfidence causes people to take their previous success, and attribute it to future circumstances, in an irrational way, while at the same time, sometimes underestimating their competitors.
In Crypto, Outcomes Can Be Amplified
Crypto trading, in particular, can easily lure traders and investors into a false sense of confidence, depending on the market cycle. Not long ago, for example, a $100 dollar investment in Ripple (XRP), placed at the right time, could have netted investors up to a $35k dollar profit.
XRP was one of the more extreme profit potential examples. However, it was not uncommon to hear of people randomly investing money into crypto and making very sizeable profits in virtually no time at all, mostly as the result of luck.
When a person has this type of success, it can often lure them into thoughts like “hey, this is easy”, or “I am really good at this!” Even traders can often find it easy to fall into a sense of euphoria, as many did in January 2018, before the crash started.
So What Can Be Done To Combat This?
Just as with fear, it is important to try to remain objective and not allow previous outcomes to have too much impact. It is important to remain level-headed, to see the whole picture, and to use proper risk management while realizing that tides can change quickly.
Underestimating the Opponent
As seen in Freedman’s quote, overconfidence also causes traders to underestimate their opponents. Trading is one giant competition. It’s a zero-sum game, meaning in the long term that when someone wins, someone else must lose. Trading is against another person, business, entity, etc. Overconfidence can lure traders into thinking that their opponent is inferior, thus setting the tone for an upset (loss).
This is extremely common in sports. That is why upsets happen. When a certain team is in first place, or on a winning streak, and begins to take a more relaxed approach to their game or their preparation/training it can lead to a losing team surprising them or outworking them.
The 2006 Chicago Bears may be an example of overconfidence. The Bears were on track for an undefeated season, with 7 wins and 0 losses, heading into a game (Nov. 5, ‘06) against the Miami Dolphins, who had 1 win and 6 losses. The Dolphins managed to beat the Bears with a score of 31-13. It is difficult to believe that this outcome was not the result of overconfidence, at least to some degree.
In trading, this can be seen in situations where a trade has worked several times in a row, leading a trader to take a subsequent trade too quickly, without analyzing all the data or following their whole process, thinking “I am a great trader and can’t lose lately”. In crypto trading especially, it may be helpful always to keep a level-headed perspective, keeping risk management as a priority, and evaluating all the data, even when things are going astronomically well.
“You’re never as good as you think you are when you win; and you’re never as bad as you feel when you lose.” – Joe Paterno (College Football Hall of Fame).