As we all know, if you roll a fair, six-sided die, you can choose any number between one and six, and you will clearly have a one-sixth chance of being correct. Now, let’s assume you were told that the last three rolls of the die have produced the number 4. If you were to roll the die again, what number do you think will come up and what is your chance of being right?
A. 4, as it has more than a one-sixth chance of being rolled again
B. Anything but 4, as it has a lower than one-sixth chance of being rolled again.
C. Any number 1 through 6 has a one-sixth chance of coming up.
The way that you respond to this question may tell a lot about your approach to investing. Most investors are overconfident. In many cases, overconfidence comes from the illusion of knowledge. Psychologists have determined that overconfidence causes investors to overestimate their knowledge, underestimate risk, and exaggerate their ability to control events. Many investors believe that more information increases one’s knowledge about something and improves one’s decisions.
You see, the added information of knowing that the prior three rolls of the die produced 4 each time does not increase your ability to predict the outcome of the next roll of the die. However, many people believe that the number 4 has a greater chance (more than one-sixth) of being rolled again. Others believe that the number 4 has a lower chance (less than one-sixth) of being rolled again. These people think their chance of being correct is higher than what it actually is. The new information (of knowing the outcome of the prior three rolls) makes people more confident in their predictions even though their chances of being correct does not change.
Using the internet, investors have access to vast quantities of information, including historical data such as past prices and returns, as well as current information such as real-time quotes, news, and volume. However, most individual investors lack the training and experience of professional investors and, therefore, are less certain how to interpret the data. That is, this information does not give them as much knowledge about the situation as they think because they do not have the training to interpret it properly.
This illusion of knowledge leads many investors to make poor investment decisions, which often manifest themselves as excessive trading, risk taking, and ultimately portfolio losses. Whether or not you would classify yourself as any of the individuals above, it is easy to how important a disciplined investment strategy is to your overall success as an investor. GorillaTrades is an award-winning, risk-controlled investment system that produces results! So no matter how much experience you have with the the stock market, GorillaTrades has something to offer every investor!