Overconfidence: Why More Trading Often Means Lower Returns

Ask a room full of people whether they are better-than-average drivers, and a large majority will usually say yes. Statistically, that cannot be true for everyone. Psychologists call this tendency the 'better-than-average effect', and it is one of several related biases grouped under the broader heading of overconfidence. In everyday life it is mostly harmless and may even help us take on challenges. In investing, it has a measurable cost.

This article looks at what overconfidence is, what researchers found when they studied the trading records of real investors, and why the explosion of low-cost apps, intraday trading, and derivatives in India makes this topic especially relevant today.

Three faces of overconfidence

• Overestimation: believing your skill, knowledge, or chances of success are higher than they are.
• Overprecision: being too sure that your forecast is right, for example expecting a stock to be at a specific price next month and underestimating how wide the range of possible outcomes is.
• Illusion of control: feeling that watching screens closely, reading more news, or acting quickly gives you more influence over outcomes than it actually does.

A close cousin is self-attribution bias: crediting wins to skill and blaming losses on bad luck, manipulation, or 'the market being irrational'. Over time, this makes it hard to learn from experience, because the evidence that would correct overconfidence gets explained away.

What the trading records showed

Some of the clearest evidence comes from economists Brad Barber and Terrance Odean, who analysed the trading records of tens of thousands of households at a large US discount brokerage during the 1990s. In a 2000 paper titled 'Trading Is Hazardous to Your Wealth', they found that the households who traded most actively earned noticeably lower net returns than those who traded least, and lower than the market as a whole. The main culprits were trading costs and the fact that the stocks people bought did not, on average, do better than the ones they sold.

In a follow-up study published in 2001 under the title 'Boys will be Boys', Barber and Odean examined differences between men and women. Drawing on psychological research showing that men tend to be more overconfident in areas such as finance, they found that men in their sample traded considerably more often than women and that this extra trading reduced men's net returns by more. The point was not about gender as such; it was that the group more prone to overconfidence traded more and paid for it.

These were US studies from a particular period, and markets, costs, and products have changed since. But the underlying mechanism, more trades meaning more costs and more opportunities to act on mistaken confidence, is general.

Why this matters in India today

Indian markets have seen a large rise in the number of individual investors and in short-term trading, particularly in equity futures and options. SEBI has published studies of individual traders in the equity derivatives segment, and these found that a large majority of individual F&O traders, roughly nine in ten in the periods studied, lost money, with transaction costs adding meaningfully to those losses. That finding is a useful reality check against the impression created by social media, where winning trades are far more visible than losing ones.

Every trade also carries costs that are easy to underestimate when each one looks small: brokerage, securities transaction tax, exchange and regulatory charges, GST on some of those charges, stamp duty, and the bid-ask spread or slippage on entry and exit. Short-term gains may also attract higher tax than long-term holdings. A strategy has to overcome all of these before it produces anything for the trader.

A simple illustration of how costs compound

Imagine two hypothetical investors who each start with ₹2,00,000. The first buys a diversified portfolio and makes a handful of changes a year. The second, confident in reading short-term moves, trades several times a week. Even if the second investor's picks were exactly as good as the first investor's on average, the second would pay costs hundreds of times over during a year, and those costs come straight out of returns. To come out ahead, the frequent trader needs to be not just right, but right by enough, often enough, to cover every rupee of friction. That is a much higher bar than it feels like in the moment of placing each trade.

Practical self-checks

• Keep a trading journal. For every trade, write down the reason, what you expect to happen, over what period, and what would prove you wrong. Reviewing the journal every few months is one of the most effective ways to see whether your confidence is justified.
• Measure yourself against a simple benchmark. Compare your actual results, after all costs and taxes, with what a low-cost index fund would have delivered over the same period. Be honest about including every trade.
• Count your costs explicitly. Most brokers provide a contract note and a profit-and-loss statement that list charges. Adding them up for a year can be eye-opening.
• Practise before risking money. A paper-trading simulator lets you test whether a strategy works without the cost of finding out with real money, though it cannot reproduce the emotions of real losses.
• Set a deliberate limit on the number of trades per week or month, and make exceeding it a conscious decision rather than a reflex.
• Ask what you know that the person on the other side of the trade does not. In liquid markets, the counterparty is often a professional with better data, faster systems, and lower costs.

The takeaway

Confidence is useful; it lets people act under uncertainty. Overconfidence becomes expensive when it turns into frequent trading, concentrated bets, and an unwillingness to learn from losses. The research does not say that nobody can trade successfully. It says that, as a group, the most active individual traders have tended to do worse, and that the costs of activity are larger and more certain than its benefits. Tracking your own record honestly is the most reliable way to find out which side of that evidence you are on.