Superiority Trap

AAA

DEFINITION of 'Superiority Trap'

A psychological or behavioral trap that leads people to believe that they have superior skill in some areas. The superiority trap can be a dangerous delusion in the stock market, since investors who believe their investment prowess is superior to that of others may end up losing a lot of money. One way of avoiding this trap is through retaining a sense of humility, rather than hubris. An oft-cited example of the superiority trap is the fact that the overwhelming majority of people think they are above-average drivers, which is a contradiction in itself.

BREAKING DOWN 'Superiority Trap'

Investors trapped in the superior state of mind have inflated views of themselves. They are overly confident in their capabilities and investments, and they may reject good independent advice, which could lead to errors in their own judgment. The superiority trap may have been the root cause of some of the biggest financial blow-ups in history. A prime example is the collapse of Long-Term Capital Management in the late 1990s. While LTCM’s distinguished Board of Directors included Nobel Prize winners in economics, this brainpower was not enough to avoid a loss of $4.6 billion in less than four months after the Russian financial crisis of 1998.

Another illustration of the superiority trap is that of an investor adding recklessly to a losing position, backed by the assumption that he or she knows better than the market. The investor is optimistic that the market will eventually see the stock’s value proposition and push it higher. But if the stock continues to decline, the investor will eventually have to cut losses and close the position.
 

RELATED TERMS
  1. House Money Effect

    The tendency for investors to take more and greater risks when ...
  2. Hot Hand

    The notion that because one has had a string of successes, he ...
  3. Muppet Bait

    Naive investors who are lured into buying hot stocks or securities ...
  4. Lemming

    The act of an investor following the crowd into an investment, ...
  5. Herd Instinct

    A mentality characterized by a lack of individual decision-making ...
  6. Behavioral Finance

    A field of finance that proposes psychology-based theories to ...
Related Articles
  1. Active Trading Fundamentals

    4 Psychological Traps That Are Killing Your Portfolio

    Sometimes your largest financial hurdle is our head. Learn about the common mind-traps that trip up investors.
  2. Investing Basics

    Avoid These Common Investing Psychology Traps

    There are a number of very common psychological traps or errors that investors typically make. You can save a lot of money and misery by avoiding them.
  3. Trading Strategies

    Follow The Herd In Trading The Capital Market

    If you have ever heard "the trend is your friend" and believed it, you may be a fan of herd instinct mentality. This is an environment where, just like with fashion, masses of people follow a ...
  4. Investing Basics

    Behavioral Bias - Cognitive Vs. Emotional Bias In Investing

    We all have biases. The key to better investing is to identify those biases and create rules to minimize their effect.
  5. Investing Basics

    4 Behavioral Biases And How To Avoid Them

    Here are four common common behavioral biases for traders and how to minimize their effects on your portoflio.
  6. Investing Basics

    Psychological Coping Strategies For Handling Losses

    There are a variety of psychological strategies for coping with financial losses and investing mistakes.
  7. Active Trading Fundamentals

    An Introduction To Behavioral Finance

    Curious about how emotions and biases affect the market? Find some useful insight here.
  8. Options & Futures

    The Importance Of Trading Psychology And Discipline

    Find out how investing success can be more about your mindset and less about the markets.
  9. Active Trading Fundamentals

    How Market Psychology Drives Technical Indicators

    The tenets of market psychology underlie each and every charting tool.
  10. Options & Futures

    Gauging Major Turns With Psychology

    Knowing what the market is thinking is the best way to determine what it will do next.
RELATED FAQS
  1. How does days to cover a short position relate to a short squeeze?

    Days to cover a short position reveals the intensity and duration of a potential short squeeze. A short squeeze occurs when ... Read Full Answer >>
  2. Is it better practice to use a stop order or a limit order?

    Both stop orders and limit orders have their advantages and disadvantages; traders need to decide between the two based on ... Read Full Answer >>
  3. What is the difference between a buy limit and a sell stop order?

    A buy limit order is a specific type of buy order used to enter a market, while a sell-stop order is a sell order that can ... Read Full Answer >>
  4. What is the difference between a short squeeze and a long squeeze?

    A short squeeze and a long squeeze are situations that can force traders and investors out of their positions. A short squeeze ... Read Full Answer >>
  5. Why does the efficient market hypothesis state that technical analysis is bunk?

    The efficient market hypothesis (EMH) suggests that markets are informationally efficient. This means that historical prices ... Read Full Answer >>
  6. What does it mean to be absolutely risk averse?

    Some people are absolutely risk-averse, which means that they cannot tolerate sustaining any sort of loss, even a temporary ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
  2. Tiger Cub Economies

    The four Southeast Asian economies of Indonesia, Malaysia, the Philippines and Thailand. Tiger cub economy indicates that ...
  3. Gorilla

    A company that dominates an industry without having a complete monopoly. A gorilla firm has large control of the pricing ...
  4. Elephants

    Slang for large institutions that have the funds to make high volumes trades. Due to the large volumes of stock that elephants ...
  5. Widow's Exemption

    In general terms, a widow's exemption refers to the amount that can be deducted from taxable income by a widow, thereby reducing ...
  6. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically a bond or preferred stock, is surrendered. Until the call ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!