Imaginary Control and Financial Decisions

An illusion of control in the stock market diminishes returns, yet many investors continue to fool themselves. Recognizing and altering this behavior can lead to better results.

It is OK to be wrong; it is not OK to keep repeating the same mistake.”


There are mortal sins and there are venial sins. An illusion of control in the stock market surely is the former. It diminishes returns, still, many investors believe in it. Recognizing and altering this behavior can lead to better results.

Control is an illusion.Photo by Captain Hubert C. Provand first published in Country Life magazine, 1936. Courtesy Wikipedia.

For example, let’s say two people make a market bet that turns out to be profitable. The wager is on a stock, but it could be a mutual fund or an exchange traded fund. Person A attributes the positive result solely to his own analytic thinking. The other individual looks at it more broadly:

I’m glad I made a reasoned decision to buy this stock, which turned out to be profitable for me; market conditions were clearly favorable, too. I did my part but luck played a role too.”

The perspective of Person A leads to a bigger bet the next time, thinking he is solely responsible for his gain. He ignores the fact that he can’t predict future stock movement, though he can forecast expectations based on past events.

Person B, on the other hand, remains careful, knowing that the past is not the future and that the market can turn on him anytime without prior warning.

Person A is likely to lose a big bet eventually, ablating most or all of his gains. Person B is a consistent player who realizes his own limitations in the final outcome and won’t be making increasingly larger bets. Person A has an illusion of control. Person B does not.

Illusion of control

This occurs when an individual correlates past actions with a current positive outcome in spite of the fact that the positive results do not automatically mean the individual’s past decisions were responsible for current outcomes.

Those who suffer from an illusion of control often have associated ailments:

Representativeness bias

This means they anticipate that past returns will be repeated in the future. This line of thinking, though, ignores the probability that future bets each carry their own set of unique circumstances.

Confirmation bias

It further solidifies certainty to these individuals that they are doing the right thing, but offers them no benefit. It means ignoring information that does not confirm their own bias. Even if they are challenged by others, they will disregard it and instead seek out those who agree with their own thinking.

From my point of view, there are many participants in the stock market who have an illusion of control: for example, the soothsayers on CNBC, who cannot really predict the future as they and many listeners seems to believe.

Others, such as some portfolio managers, promise more than they can deliver. This is because they are endlessly optimistic about which direction the market will trend. Of course, it is in their best interest to suggest the market will continue to rise so their clients keep their money in managed accounts.

Individual investors, too, can fall victim to an illusion of control. Think of corporate employees who keep over a third of their total portfolio in their company stock, because they think they know their company and it is warranted. Enron personnel thought that, too, no doubt.

In the end, an illusion of control is just that, an illusion. If only it were different.

Further Reading:

This and other similar errors of investor thinking are covered by Morris Altman in his chapter entitled “Behavioral Economics, Thinking Processes, Decision Making, and Investment Behavior” in Investor Behavior edited by H. Kent Baker and Victor Ricciardi (Wiley, 2014).