Overconfidence Bias Definition Types Examples Overcome

Overconfidence Bias Definition

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It can happen irrespective of gender, age, experience, or field of knowledge. The overconfidence level in individuals may vary. Some people have more of it, and some have less of it. For example, a significant portion of Americans thinks they have above-average intelligence. They demonstrate overconfidence in their knowledge and abilities.

Key Takeaways

Overconfidence bias in psychology refers to the tendency of people to overestimate their abilities.It influences people to judge themselves better than others. As a result, people possess high regard and favorable view toward their abilities and reasoning.It consists of four types: Over ranking, the illusion of control, timing optimism, and desirability effect.It is a difficult characteristic among many people making them invite loss by creating high-risk decisions and actions in their day-to-day lives.

Overconfidence Bias In Finance Explained

Overconfidence bias is a general tendency of people to overestimate their skills, authority, and knowledge due to excessive confidence. It can affect their thoughts, decisions, and strategies associated with particular tasks, strategies, and outcomes.

In finance, entities’ overconfidence based on past and present success can lead to poor decision-making. The overconfidence effect can affect the rationality present in the investors. It also influences investors to indulge in trading to achieve higher returns actively. However, they often fail to get higher returns.

Types of Overconfidence Bias

Let us look at different types of overconfidence bias:

#1 – Over Ranking

It is a simple practice where people tend to overrank themselves as better than they are because no one likes to imagine themselves below average. People perceive themselves as dominant. Therefore, they can rate themselves much more than they are. So in a general sense of ranking, people tend to hide their true abilities and end up ranking themselves at least better than the average. This way, overestimating the abilities can result in taking too much risk and making heavy losses.

#2 – Illusion of Control

Everyone likes to control and imagine that they can and try to control situations. It is a very common human behavior where people usually think they operate with a sense of control. Still, in real cases, they cannot control or exert power as anticipated. It is highly dangerous when people fail to assess their authority and believe they are in total control of the circumstances. This simple trait can be very distressful and loss inviting in business and investing.

#3 – Timing Optimism

It occurs when people tend to, without any evidence, underestimate the time and effort required for them to finish a task. It can be mapped to a part of optimistic behavior, and it is wonderful to believe in our abilities and forecasting to view the world positively. However, optimism over how long something will take you to complete can be harmful in certain situations.

#4 – Desirability Effect

It is when people have a strong belief that nothing will go wrong. They expect and believe that the desired outcome will happen. It points to the overestimation of the likelihood of the ideal result.

Examples

Let’s look into overconfidence bias examples for better understanding:

Example #1

GGP Inc. is an American commercial real estate company. In 2009, it was the subject of the biggest real estate bankruptcy in American history. GGP owned more than 200 malls at its height, and its stock was trading favorably. However, the business was saddled with debt in 2008, with a sizable portion of that debt coming due.

In addition, the company faced difficulty refinancing its debt following the market’s collapse of the commercial MBS. As a result, its shares sharply declined, and the business declared bankruptcy. The corporation had numerous chances to generate money by selling equity, but affected by overconfidence bias lost the chance to sell shares profitably.

Overconfidence bias in investing can result in poor investment decisions. It is one of the reasons amateur investors fail when they attempt to time the market influenced by market highs and rallies. So it was when many investors highly advised that people and new retail investors must not let the bullish trend in the market influence them and take risks they could not afford out of overconfidence.

It is easy to get influenced when people see their money getting double and triple within a few days. Still, anyone and everyone must have rational thinking and not let overconfidence take their driving wheel.

How To Overcome?

Seek information that contradicts the findings.While making decisions, first of all, people should think of the end goal and outcome and what will happen if things don’t turn out as expected. What if this went wrong; what if that didn’t go well; studying every possible detail or last-minute error refines the overconfidence bias behavior into a critical thinking aspect.Whenever there finance and money are involved, people should always keep an open mind, be humble about scenarios and be sincere about constantly checking things to ensure they are moving according to the plan.One of the most crucial habits to overcome is learning from one’s mistakes. Another important practice to overcome overconfidence bias in decision making is to accept feedback and peer review and execute them. When people give their advice and opinion, it is always good to listen to them; this way, it is respectful and insightful, and at the same time, it is learning from other people’s experiences.Fear can be healthy. It can create a driving force that stops people from making bad, quick, and reckless decisions.