V.9:5 (206-207): Avoiding Overconfidence by Van K. Tharp, Ph.D.

Avoiding Overconfidence by Van K. Tharp, Ph.D.

If I could give just one piece of advice to a trader, it would be: Avoid overconfidence—it could be your worst enemy. Thousands of traders make the mistake of becoming overconfident each month and lose substantial amounts of money. For example, the following incidents were brought to my attention just recently:


A trader — whom we will call Henry — needed to make $7,000 each month to meet his living expenses. This particular month was exceptional; he made $20,000 in two weeks making low-risk trades and following his own trading rules. He was feeling on top of the world; he could do no wrong. One Friday morning, however, he noticed a marginal trade that involved more risk than he normally took. Henry decided to take it. The market immediately went against him and he was stopped out for a $1,500 loss. His money management rules called for a maximum risk of $1,000 on a trade, so his early morning results were totally unacceptable. As a result, he quickly opened up another high-risk marginal position. By the end of the day, he'd lost a total of $4,500. The following Monday he was still upset about losing $4,500. He took several more high-risk trades, only to lose another $3,500.


A trader in the Midwest told me that he had made $80,000 in profits on a $40,000 account in two months of conservative trading. Then, he said, he stopped paying attention to risk — and blew out his total profit in two weeks.


I visited a client in New York and spent some time talking to the firm's president about his trading. Indirectly, the company president mentioned how he was trading — he had most of his money tied up in large spread positions. I looked at what he was doing and told him that it could cost him his company. In response, he told me that he was totally protected — that it was a spread position with zero risk. Two months later, the firm lost $1.5 million from that position.