94% of college professors rank their work as above average. Hmm…simple statistics tells us only half will be above average. Yet this holds true for the general public too; most people think they are above average drivers too. And on the other end of the scale, Darwin once wrote that:
“Ignorance more frequently begets confidence than knowledge“
So, how does this all relate to making money in the stock market. And what does it have to do with the Dunning-Kruger effect?
An example of the Dunning-Kruger effect would be the case of an unskilled person, who makes poor decisions and reaches incorrect conclusions, failing to realize their mistakes. Essentially, their incompetence denies them the metacognitive ability to realize their mistakes. This is sometimes described as illusory superiority, involving rating one’s own ability as above average as we saw in the case of the professors. The flipside of this phenomenon is illusory inferiority in which competent individuals falsely assume that others have an equal understanding and so underrate their abilities.
In the stock market, an example of the Dunning-Kruger effect comes into play when people, who are truly skilled at what they do, and have made money consistently in the market, question their own ability. They believe that they are just not as good as their results demonstrate. And it also comes into play when people, who are not as proficient, believe that they are in fact better than they truly are.
For a human, it is especially challenging to come to terms with the Dunning-Kruger effect, especially if performance has not been that good. Why? Because it is a direct strike at the ego. And it is a quick spiral downwards from poor results to the Ostrich Effect, which you can learn more about by clicking here.
As a person who underperforms yet overbelieves, the solution is to learn more, practice and improve as a trader. On the other hand, if you are in the enviable position of being an overachiever but not giving yourself permission to accept that, your job is to Believe in yourself, just not that much…or the pendulum can quickly overswing toward excess confidence!
