Is overconfidence good for traders?

A little confidence is a good thing. But a lot of confidence may be even better — particularly if you’re a high-powered currency trader playing the international money markets.

Finance professor Carol Osler found that at least some of the wild and unexplained fluctuations in currency markets may simply be due to overconfident money traders. “Overconfidence can help you get ahead, but it can have serious ramifications, too,” says Osler, who teaches at the International Business School at Brandeis University.

Osler and her research colleague, psychologist Thomas Oberlechner of the University of Vienna, interviewed 416 currency market traders. They asked these wheeler-dealers to rate how successful they were as traders on a seven-point scale ranging from “much less successful” than other traders to “much more successful.” They also asked the traders’ bosses to rate the employees’ value to the firm, and then asked the traders to estimate what the exchange rate of five currencies would be in six months and in a year.

The first thing they learned is that — surprise! — most currency traders have outsize egos: Nearly three in four rated themselves as “better than average.” Even most traders working at less prestigious institutions thought they were better than most, Osler and Oberlechner reported in a paper they have presented at two European universities and at Harvard.

The distinct whiff of hubris was confirmed when they compared the traders’ self-evaluations with the supervisors’ ratings. More than half of the traders gave themselves a higher rating than their supervisors did, while few underestimated their value.

The researchers found that this self-confidence had no impact on a company’s bottom line. But it had a dramatic and positive impact on the careers of traders, increasing their chances of becoming a senior trader or chief dealer, when other factors such as age and trading success held constant.

Here is the link. Here is Carol Osler’s home page.

My take: I have mixed feelings about the core result. On one hand, competition is thick and you have to take chances to win special positions in life. This requires a certain amount of hubris. That being said, I worry about selection bias in the results. You only observe the ones who made it. Try asking the bankrupt currency traders, lying in the proverbial gutter, if cockiness was good for them. And let’s not forget about those in jail, or headed there.