Commissions for online trading have dropped dramatically in recent years. In our full sample, investors pay an average bid-ask spread of 1 percent. The online environment fosters cognitive biases that lead to overconfidence. One such bias is the illusion of knowledge. Studies show that, as people acquire more information, their confidence in their ability to predict outcomes rises far faster than the accuracy of their predictions.
Online investors have access to vast quantities of data.
This data may give them a false confidence that they can pick stocks. Unfortunately, data related to a task aren t always relevant to the task. Suppose you wished to predict the next number to come up on a roulette wheel. You could know all the historical outcomes on that wheel, and a great deal about how, where, and to what specifications the roulette wheel had been manufactured, but you wouldn t know which number was going to turn up next. Billions of bytes of market data give most investors no more ability to pick individual stocks than to pick numbers on a roulette wheel.