Have you ever noticed someone read a little about a diet, try it for a short time, and then start talking about it as if they were a nutritionist? They don’t just say, “It worked for me”; they may insist it’s the best diet for everyone. The irony is that a true expert, despite years of study, is usually more cautious about making sweeping claims—because they know how many exceptions and details can change the answer.

Something similar can happen in investing, but at a financial cost. Someone learns the basics of stocks, reads about analysis, makes a profit on their first two trades, and suddenly feels they’ve “figured out the market.” But they later discover that making the right investment decision involves an entire world of: valuation, risk management, macroeconomics, diversification, behavioral finance, and much more.

This paradox is widely known as the Dunning–Kruger Effect. In their original 1999 study, Justin Kruger and David Dunning found that people with limited skills tend to overestimate their abilities. The reason is that a lack of skill can itself prevent people from seeing their mistakes; in other words, the problem isn’t just “what you don’t know,” but sometimes that you don’t know how much you don’t know.

But it’s important not to interpret this effect as meaning that “every beginner is arrogant.” The scientific interpretation of this phenomenon is still debated among researchers. In fact, recent research published in leading scientific journals such as Psychological Review has reexamined how this confidence is measured. So the more financially useful approach is to treat this phenomenon as a starting point for a broader, deeper question in the world of finance: What happens when your confidence in a decision far exceeds your actual ability to make it?

When overconfidence becomes an investment decision

The problem in the market isn’t that investors have confidence in themselves; decisions require some confidence. The problem is miscalibrated confidence—when an investor believes their ability to pick stocks, time their entry and exit, or assess risk is better than it actually is.

And here, we’re not relying only on theoretical psychological analysis. We have documented financial evidence from actual trading activity:

  1. Overconfidence takes more than one form (Glaser and Weber study) The researchers linked psychological tests with investors’ actual trading records and found that those who believed they were “above average” in their skills traded more and switched stocks more often, even though their actual results were no better than those of other investors. The lesson is that overconfidence takes different forms, and not every investment decision should be reduced to a single psychological cause.
    Many people fall into a familiar cycle:
    Limited knowledge ← confidence greater than the knowledge warrants ← bolder decisions ← more trading, greater risk, and more mistakes.
    This cycle shows up in behaviors we see every day: trading frequently simply because of a feeling that you have “inside information,” putting all your cash into a handful of stocks, treating a social media tip as if it were in-depth analysis, or taking profits on two consecutive trades as proof of lasting skill.
  2. Excessive trading eats into returns (Barber and Odean study) In one of the best-known financial studies, which examined 66,465 investment accounts, the households that traded most and switched stocks most often earned an annual return of just 11.4%, while the market as a whole returned 17.9%. The researchers concluded that active trading exacts a steep performance cost from individual investors, and that overconfidence in one’s ability to beat the market is the main driver of frequent trading.
  3. Feeling capable diminishes the value of diversification (Goetzmann and Kumar study) The researchers found that many individual investors concentrate their portfolios in very few stocks (often domestic stocks or companies whose trends they follow). This doesn’t mean overconfidence is the only reason investors concentrate their portfolios, but the study shows how an exaggerated sense of one’s ability to “pick the winning stock” can lead investors to underestimate the importance of diversification.
  4. The first-win trap and self-attribution (Statman, Thorley, and Vorkink study) Success itself can become a trap! The researchers found that higher past returns are followed by an immediate increase in trading volume. This is due to a psychological bias called self-attribution bias: when trades succeed because the market as a whole is rising, investors credit their personal intelligence and skill rather than luck. Their overconfidence grows, they trade more, and they later face greater losses.

From an investor’s mistake to market movements

What if this behavior weren’t an individual case, but something repeated by large numbers of investors in the market at the same time?

That’s when the issue moves from personal finance and individual mistakes to financial market economics.
Researcher Terrance Odean’s model shows that the presence of overconfident investors increases expected trading volume in the market. But it also offers an important caveat: the effect of overconfidence on volatility and price quality is not the same in every market; it depends on who is overconfident, what information they have, and how information is distributed among participants.

That’s precisely why claiming that “the Dunning–Kruger Effect is the direct cause of financial bubbles” is scientifically inaccurate. A more accurate view is that overconfidence is one of the mechanisms that can amplify speculation and mispricing when it combines with other conditions.

How does this happen within the market? Two models help explain it:

  • Overreaction (Daniel, Hirshleifer, and Subrahmanyam model): When investors are overconfident in the accuracy of their “private information” and confuse successful trades with their own skill (self-attribution bias), they overreact (or underreact) to news. This can cause price swings that exceed what companies’ actual financial data would justify.
  • Betting on others’ exuberance (Scheinkman and Xiong model): This model shows that when investors disagree about the value of a stock and are influenced by “overconfidence,” an investor may buy it at a high price not because it is worth that much, but because they are confident that another, more exuberant investor will buy it from them at an even higher price later. In the absence of mechanisms to regulate prices and prevent them from becoming inflated, an inflated price detached from reality emerges—a bubble—accompanied by heavy trading and sharp volatility. This is a possible theoretical mechanism, not proof that overconfidence alone creates every bubble.

Put simply, the cycle can be summarized as follows:

Limited knowledge ← uncalibrated confidence ← excessive or biased trading ← potential asset mispricing ← lower market efficiency.

But the word “potential” is crucial here. A large number of market participants and a high volume of trading are not inherently bad; they provide the market with liquidity and information. The real danger appears only when that liquidity turns into trading based on the illusion that one can read the market, temporarily pushing prices away from their true economic value. Put simply:

Why does this matter to the economy, not just your portfolio?

The financial market isn’t merely a place where individuals make or lose money; it serves a key function in the economy: directing capital. Accurate prices guide investors and companies toward the right places to put their money and grow the economy.

When large amounts of money flow into companies or assets priced too high because of an “investment fad” or “overconfidence,” that money is diverted from other companies that may be more productive and beneficial to the economy. This is known as a decline in capital allocation efficiency.

Why does this matter in the Saudi market?

This issue is especially important in today’s Saudi market, as digital investment channels expand rapidly and individuals gain easier access to the market:

1. A sharp rise in the number of investors and digital apps

  • According to the Saudi Exchange Statistical Annual Report, the number of individual investors reached approximately 7.16 million by the end of the fourth quarter of 2025. They held 14.57 million investment portfolios (excluding closed portfolios).
  • In the financial technology (FinTech) sector, the Capital Market Authority announced that the number of users of digital investment solutions rose by 35% to more than 1.06 million investors in 2025 (up from 789,800 in 2024). Assets managed through robo-advisory platforms also exceeded SAR 6.4 billion.

These developments are very positive for deepening the market and making investing more accessible. But they also make it essential to clearly distinguish between “easy access to investing” with a tap of a button and “easy understanding of investing” and managing its risks.


2. Research evidence from the Saudi market (the Alsabban and Alarfaj study) There is also a direct local research finding: researchers Alsabban and Alarfaj (Alsabban & Alarfaj) studied Saudi market data from 2007 to 2008 and found a relationship between higher past returns and an increase in the subsequent turnover rate, interpreting this as consistent with “overconfidence” behavior.

For the sake of scientific accuracy, however, it’s worth noting that this finding measures overconfidence indirectly and at the level of overall market activity, rather than directly testing each individual investor. Research working papers issued by the central bank/Monetary Authority express the researchers’ views and do not necessarily represent the bank’s official position.

3. Awareness and protection from “social media experts” The impulsiveness associated with overconfidence is often fueled by unreliable financial content. We have documented reason not to treat every “expert” on screen as trustworthy: in March 2026, the Capital Market Authority announced that an individual had been found guilty and fined SAR 250,000 for providing advisory services without a license through Telegram and advertising them on (X).

This case doesn’t mean all financial content on social media is bad, but it highlights the importance of assessing expertise through licensing and scientific methods, not follower counts or an assertive tone of confidence.

4. Initiatives to raise investment awareness (Thameen Program) To address these challenges, the Capital Market Authority runs Thameen, an awareness program designed to improve investment literacy. It offers educational materials, financial literacy assessments, and simulated trading experiences without real-world risks to help individuals make balanced decisions and allocate their savings efficiently.

True knowledge doesn’t eliminate confidence—it puts it in perspective

The message of all this isn’t “don’t trust yourself” or “stay away from investing.” It’s this: always keep your confidence in proportion to your experience and the evidence you have. A mature investor isn’t someone who has a definitive answer to every market movement, but someone who understands what they know and when to stop because their knowledge isn’t sufficient.

What modern psychology and finance have shown through the “Dunning–Kruger Effect” was expressed centuries ago by wise people and scholars in eloquent sayings that explain how “the first span of knowledge is the peak of the illusion of knowing, while deeper exploration is the beginning of awareness of how much we don’t know”:

  • The trap of intellectual arrogance (the first span): When someone settles for superficial knowledge and thinks they have mastered the market, they fall into the trap Abdullah ibn al-Mubarak warned against when he said:

“A person remains learned as long as they seek knowledge. But when they think they have learned, they have become ignorant.” The same idea appears in the saying that knowledge has three spans: “Knowledge has three spans: whoever enters the first becomes arrogant; whoever enters the second becomes humble; and whoever enters the third realizes that they know nothing.”

  • Intellectual humility (the mature investor): By contrast, the more deeply an investor understands the complexities of markets and risk management, the more aware they become of their own limits—just as Imam al-Shafi‘i said:

“The more life teaches me ... the more it shows me my lack of wisdom.
 And the more knowledge I gain ... the more I learn how little I know.”
This echoes Socrates’ famous saying: “All I know is that I know nothing.”

The final financial lesson: In the world of stocks, the more confident you are in a particular investment decision, the more you should question the evidence, the risks, and what you may have overlooked. Knowing the limits of what you know is your first line of defense, and it can sometimes matter far more than being confident that you have all the answers.