Counting pennies, losing pounds: Biased learning about own trading ability

Abstract

We study the behavior of retail day traders to shed light on the causes of overconfidence in financial markets. We show these individuals assess their trading skills using a simple counting heuristic: the proportion of profitable days. This yields an upward-biased performance measure, as individuals exhibit a strong disposition effect that artificially inflates the proportion of profitable days. We develop and estimate a model showing that without the disposition effect, the counterfactual proportion of profitable days would be 47%, compared to the actual 52%. Our findings show that the disposition effect, combined with simple heuristics for evaluating performance, generates overconfidence.

Keywords: overconfidence, retail investors, counting heuristic, disposition effect

JEL Classification: G11, G40, G41