Did You Lose Money Trading Stocks? Blame Your Caveman Brain

Ever since COVID stimulus cheques hit bank accounts across the Western world, “retail” traders (regular people like us) have been pouring money into the stock market. According to one estimate, the number of Canadians who invest on their own has roughly doubled over the past few years. On one hand, it’s good that regular people are directly investing in stocks, which have historically been the best way to grow one’s savings. On the other hand, decades of research show that retail traders tend to be overconfident traders. And overconfidence — that is, believing so fully that you’ve cracked the market that you ignore the risks — can lead to costly blunders. Here’s a breakdown of what causes overconfidence, and what you can do about it. 

Blame your caveperson brain. Like all humans, investors rely on certain evolutionary mental shortcuts — heuristics, if you’re fancy — to make sense of the world. These are great when you’re, say, deciding whether to join other Homo sapiens in fleeing from a bear. But when we encounter complex systems in modern life (hello, stock market), these shortcuts can become cognitive biases, or patterns of erroneous thinking. Here are some of the most common biases that affect investors:

• Anchoring: We cling to our first impressions of something (like, say, a company whose stock was on fire when we first started paying attention to it) even when we should be changing our view.

• Herding: We assume that if everyone else is making a certain choice, it’s probably the right one. (Spoiler: it’s probably not.)

• Selective forgetting: We remember our wins more than our losses.

Overconfidence in action. Combine these biases and you’ve got a recipe for investing overconfidence. Studies have found that when retail investors are convinced they’ve found a winning stock, they tend to: (1) trade too much, (2) diversify too little, and (3) pile into name-brand companies with simple business models they can easily grasp. And when the market dips? Overconfident investors are (4) more likely to sell low. Men are especially prone to overconfidence, as are people who’ve been spending significant time on Google or message boards. 

Protect yourself from presumptions. Here’s the good news: you don’t have to invest like a man who thinks he solved the stock market after 10 minutes of reading Reddit. Start by gathering information from a wide range of reputable sources instead of relying on a single perspective. Many libraries offer remote access to The Wall Street Journal, the Financial Times, and other first-rate business papers if you don’t have extra cash to subscribe. And, for the love of all that is good and right, be deeply skeptical of anything stock-related you see on TikTok, or any social-media site. 

Accept that picking stocks is tough. So tough, in fact, that pro fund managers rarely beat the major indexes over time. To be a star stock picker, you often need to ignore the crowd and ignore the companies everyone is already blabbing about. That’s because if everyone knows that a company is great, then its stock will be expensive, which means the company must really overperform to push its shares higher. Which ain’t easy. In many cases, if you want to notch market-beating returns, you need to have a non-consensus view about which stocks will beat expectations — like, maybe you believe an overlooked company will profit huge from a big shift in business. These sorts of calls are hard to get right. Even if you’re convinced your non-consensus view is spot-on, consider spreading your money around a bit, to up your odds of picking a winner. (Or you could follow the advice of Warren Buffett and invest in low-cost index funds that bet on the whole market — but that’s another topic for another day.) One more thing: make sure you’re able to withstand temporary setbacks. If you’ve taken on too much risk, you’ll be more inclined to panic-sell when the markets inevitably fluctuate. Operating from a place of security, with some cash in the bank or stable assets to your name, will help prevent your caveperson brain from taking over — in good times or bad.

Written By

Ben Mathis-Lilley

Ben Mathis-Lilley is a senior writer for Slate.com and the author ofThe Hot Seat: A Year of Outrage, Pride, and Occasional Games of College Football. He's also written for BuzzFeed and New York magazine.