Overconfidence vs Under Confidence in the Stock Market

We all know that investing is essential to long-term wealth creation, as it can be a very rewarding and potentially lucrative venture. But I was surprised when presenting to a large audience of entrepreneurs last week that while some were under confident, many others were overconfident, which makes me wonder which is better.

Would you give all your money to someone with your knowledge and skills?

Being under confident means the investor is more conservative in their approach, as they prefer to invest in assets that are deemed safe. While those who are overconfident tend to take risks and often fall victim to the illusion of control, as they believe their knowledge, experience or gut feelings can predict the market, which is often not the case.

They also tend to overestimate their abilities and underestimate the complexity of their investment decisions. All too often, they assume that past successes are based solely on their skills rather than a combination of factors, which usually includes luck and/or favourable market conditions like many who invested in the Bitcoin boom.

Overconfidence also leads many not to do the required research and analysis. Instead, they rely on rumours or tips from all manner of unreliable sources. The challenge with this is that they falsely assume that their gut feeling is infallible, which often leads to poor investment decisions.

They also fail to adapt and learn from their past mistakes even when they are presented with solid facts, which is something I observed last week. Their unwillingness to adapt is because they fail to acknowledge when they are wrong or when market conditions have changed and prefer to dig in their heels, and fold their arms in stubborn defiance.

When it comes to investing, particularly in the stock market, it is crucial that you approach it with a balanced mindset combined with a dose of caution. Overconfidence is a lot more dangerous than under confidence, as it tends to undermine sound decision-making and exposes you to unnecessary risks and potential losses.

Recognising when you are reacting from an overconfident mindset is not easy, as it requires self-awareness, humility, a commitment to gain the right knowledge and to take a disciplined approach to investing. This also applies to those who are under confident, as investors who are self-aware can mitigate any negative effects and increase their chances of achieving long-term financial success.

A good way to become self-aware is to ask yourself if you would give all of your money to someone to invest it with your knowledge, skill and experience. If the answer is no, then you are well on your way to becoming a better investor.

What were the best and worst performing sectors last week?

The best performing sectors included Consumer Staples up 2.07 per cent followed by Utilities up 1.47 per cent and Healthcare up 0.29 per cent. The worst performing sectors included Energy down 4.85 per cent followed by Information Technology down 4.29 per cent and Materials down 3.79 per cent.

The best performing stocks in the ASX top 100 included Endeavour Group up 5.20 per cent followed by AGL Energy up 4.34 per cent and Woolworths up 3.21 per cent. The worst performing stocks included IDP Education down 10.66 per cent followed by Virgin Money down 9.67 per cent and Cleanaway Waste Management down 7.91 per cent.

What's next for the Australian stock market?

As I have said in the past, a week can be a long time in the stock market given that last week the All Ordinaries Index displayed the extremes of both bullish and bearish sentiment. After rising over 3 per cent in six trading days, the market fell 3.48 per cent in the last three trading days causing investors to scratch their heads. So, once again the market appears to be defying logic or is it?

After rising for six straight days, it is normal to see a few days down, as markets don’t just trade up or down, rather they exhibit a stair like rise and fall. What this means is that it is normal for the market or a stock to travel in one direction for several days and then retrace some of the distance it moved while still maintaining the overall longer-term trend.

The concerning issue right now, however, is the severity of the fall over the last three trading days which has validated my words of caution over the past few weeks. Given the severity of the fall, probability now suggests the market will continue to trade lower and possibly down below 7,000 points. That said, as we have seen anything can happen in the stocks market, as emotions are still elevated, which is causing stocks to be punished quite quickly for what is perceived to be negative news.

While the bearishness in the past three trading days could just be a false move down before the uptrend continues, it will pay to remain diligent and not take on any unnecessary risks. If the All Ordinaries Index does fall below 7,257 points in the coming week, then we can expect further falls over the next month.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.