You will be able to explain how overconfidence leads to more trading and lower returns.
Hui Min would have told you she wasn't a frequent trader. She bought or sold "now and then", when she read something interesting or a stock looked cheap. When she exported last year's contract notes from her broker for this lesson, she counted 36 trades. She'd remembered about a dozen. The other two dozen had each felt like a one-off, a sensible reaction to news, and none of them had felt like part of a habit.
The finance professors Brad Barber and Terrance Odean studied the records of tens of thousands of households with accounts at a large US discount broker in the 1990s. Their best-known finding is in the title of their 2000 paper, Trading is hazardous to your wealth. The households that traded the most earned noticeably lower returns, after costs, than the households that traded the least. Much of the difference came from trading costs, and the trades themselves didn't make up for them: on average, the shares people bought did no better than the shares they sold to pay for them.
In a later paper they compared men and women in the same data. Men traded more than women, and their returns after costs suffered more as a result. Barber and Odean linked both findings to overconfidence. The point isn't that men are worse investors. It's that whoever is more confident tends to trade more, and trading more tends to cost more.
These studies looked at US investors decades ago, when trading costs were higher than many people pay today. Lower fees shrink one part of the problem. They don't touch the other part, which is that frequent trades driven by confidence don't reliably pick better investments than the ones they replace.
Overconfidence is the tendency to believe your knowledge, judgement or timing is better than it is. In investing it shows up in a few common forms. You think the article you just read gives you an edge, when thousands of other investors read it the same morning. You remember your good trades more clearly than your bad ones, so your record looks better in memory than on paper. And you feel that a run of good results reflects skill, when in a rising market almost everything goes up.
Critical thinking and better decisions covers overconfidence as a general bias. In investing it has a particular cost, because every belief that you know better turns into a trade, and every trade has a price.
Trading costs come in several layers. There's the broker's commission or fee, often with a minimum per trade. There's the bid-ask spread: you buy at the higher asking price and sell at the lower bid price, so a round trip loses the gap even if the price doesn't move. Investing 101, lesson 6.2, Limit orders, market orders and the bid-ask spread, explains how that works. For overseas shares there may be currency conversion costs, and some markets charge stamp duty or taxes on trades.
Here's Hui Min's year with example figures. Suppose each trade cost her S$25 in fees, and the spread cost her about 0.2% of a typical S$5,000 trade, or S$10. That's S$35 a trade. Across 36 trades, it comes to S$1,260 in a year. On a portfolio of about S$30,000, that's 4.2% of the whole portfolio gone in costs before any of the trades had a chance to make or lose money. Your own fees will differ, so look them up on your contract notes rather than using these.
That cost is certain. The benefit of each trade was a guess.
The best check on overconfidence is your own record, written down, because memory will flatter you. Counting does two things. It shows how much you actually trade, which is usually more than you think. And if you go further and compare each trade with what would have happened if you'd done nothing, it shows whether your trading adds anything at all.
Hui Min went further. For each of her 36 trades, she noted whether the stock she bought did better or worse over the following six months than the one she sold to pay for it. It came out roughly even, a little worse than even. So she had paid S$1,260 for a set of decisions that, taken together, did about as well as standing still. She didn't feel stupid. She felt the way most people feel when they first see their own numbers, surprised that the story in her head and the record on paper were so far apart.
Lesson 6.6 asks you to do this kind of audit properly. For now, start with the simplest part.
Go through your broker statements or contract notes for the past year, count your trades, and add up what they cost you in fees and spreads.
Count your trades in the past year and write the total cost in fees and spreads.
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