Module 12   Innerworth — Mind over marketsChapter 390

Walking the Tightrope Between Confidence and Overconfidence

A winning trader is confident. It’s essential to have the proper amount of confidence, however. If you are under-confident, you’ll never be a winning trader, but if you are overconfident, you may overextend your trading knowledge and assume that you have skills that you don’t actually have.  Building genuine, rock-solid confidence in one’s trading abilities takes time. It’s necessary to experience a variety of market conditions and learn which trading strategies work best under which specific conditions.

 

It’s not something that happens in just a few months, and some trading experts say it takes several years of trading before one moves from the status of a newbie to that of a seasoned trader. In the meantime, novice traders walk a tightrope between under- and overconfidence: sometimes they feel they don’t have enough confidence while at other times they may have too much. It’s often hard to find the right balance when first starting out, but it’s an issue to cope with until consistent profitability is achieved.

Perhaps it’s a given that a new trader’s account balance will rise and fall with the ebb and flow of the markets, but it’s possible to gain some control over extreme fluctuations. The most obvious way to gain control is to manage risk carefully, so a series of losing trades will not deplete your trading capital as rapidly. Just as with learning any new skill, it’s also useful to start out slowly. One may want to stick with a few solid, basic trading strategies and execute them under ideal market conditions.

For example, conventional wisdom says, avoid the open. A novice trader might do that at first and as an added precaution, only trade in bull markets, and take small profits, just to get a feel for the markets. It may not be a very innovative strategy, but it will help build confidence. If you’ve been trading the markets in the past year, it’s been relatively easy to use a simple buy-and-hold strategy. One could have bought the QQQ, for instance, and held it for a year and realized substantial gains. Again, it’s not much of a trading strategy, but it helps build confidence.

Just as a young child must venture out into the unknown, a novice trader eventually must explore new trading strategies and trade under more chaotic market conditions. It’s at these times where a typical novice trader becomes overconfident.

He or she may cope with feelings of vulnerability by building up a false sense of confidence. Perhaps it is out of inexperience or a need to bolster one’s wavering confidence, but the novice trader may feel an unjustified sense of omnipotence when facing uncertain and potentially threatening market conditions. Telling yourself that you are powerful and infallible can help you feel that you can conquer the most difficult challenge, in the short run, that is. In the long run, it can spell disaster. One may trade low probability setups without a clearly defined plan or adequate risk controls.

Building a strong sense of trading skills is key to achieving consistent profitability. It’s how you go about it that is most critical, however; one can do it in a reckless, haphazard approach or build up skills with a well-planned controlled approach. Keep in mind that when trading under new market conditions and with new trading strategies, you are taking greater chances, and it’s at these times when you need to carefully manage your risk and steadfastly follow your trading plan. By taking such precautions, you will minimize potential harm and be able to master new domains.

The piece of mind you gain through a well-defined trading plan and adequate risk controls will allow you to tackle new challenges with enthusiasm and vigor. Over time you’ll master new strategies and gain a strong, intuitive sense of new market conditions. With increased practice, you’ll achieve long-term profitability. So don’t fall off the tightrope without a safety net. Trade with the proper amount of confidence, and if you do need to take risks, acknowledge the tendency for overconfidence and take precautions to prevent it from interfering with your goals of achieving lasting profitability.

 

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