Illusion of Control Bias: Why You Think You Can Beat the Market

Abraham Lincoln said: “I claim not to have controlled events, but confess plainly that events have controlled me.” If Lincoln could admit that, why can’t most investors?

Chapter 8 of Pompian’s book covers the illusion of control bias. This one is fascinating because it reveals something deep about human psychology. We desperately want to believe we are in charge. Even when we clearly are not.

The Craps Table Problem

Here’s the thing. In the casino game craps, research shows that people throw the dice harder when they need a high number and softer when they need a low number. They genuinely believe that how they throw the dice affects the outcome.

The dice don’t care how hard you throw them. The outcome is random. But your brain cannot accept that you have zero influence over something you are physically doing.

Some people who correctly predict coin tosses actually believe they are “better guessers” and that distractions might hurt their “performance.” At a 50/50 random task. Think about that.

The Official Definition

Ellen Langer at Harvard defined illusion of control as “an expectancy of personal success probability inappropriately higher than the objective probability would warrant.” In simpler words: you think you are more likely to succeed than math says you should be.

Langer found that four things inflate this illusion: choice, familiarity, competition, and active involvement. When people got to choose their own lottery numbers, they were willing to pay more per ticket than people with random numbers. Same lottery. Same odds. But choosing the numbers made people feel like they had better chances.

The Elephant Guy

Pompian includes a funny story in this chapter that I love.

A man in a small town goes to the town square every day at 6 PM with a checkered flag and a trumpet. He waves the flag and blows the trumpet, then goes home.

A police officer asks him what he is doing.

“Keeping the elephants away,” the man says.

“But there are no elephants in this town,” says the officer.

“Well then I’m doing a fine job, aren’t I?”

This is the illusion of control in a nutshell. Just because you did something and nothing bad happened does not mean your action prevented the bad thing. Correlation is not causation. But your brain really wants it to be.

The Gambling Experiment

Researchers Breinholt and Dalrymple at Westminster College ran a clever experiment. They had 281 students play an online card game called “Red & Black” where the odds were exactly 50/50.

Some students were in a “high-involvement” group. They got to shuffle the cards, deal them, choose the target color, and pick their wager amount. Other students were in a “low-involvement” group where the computer did most of the work.

The result: high-involvement students wagered significantly more chips per hand. They felt more in control of the outcome because they were doing more physical actions. But the odds were identical for both groups.

Even more interesting: when the high-involvement group got a descending sequence of wins (lots of wins early, fewer later), they wagered even more. Early success combined with active involvement created a strong illusion that they were controlling the game.

Four Ways This Hits Investors

1. Excessive trading. Online trading platforms make investors feel in control. You are clicking buttons, reading charts, making decisions. All that activity creates the illusion that you are steering the ship. But research by Terrance Odean showed that more trading actually leads to lower returns. Every time you trade, you pay transaction costs and taxes. And your “insights” are statistically no better than random.

2. Underdiversified portfolios. Investors gravitate toward stocks they feel they can control or influence. Maybe they work at the company. Maybe they know the industry. Maybe they just follow it closely. They concentrate their portfolio in these stocks because the sense of control feels safer than diversification. But it is not safer. It is more risky.

3. Limit orders as false control. Some investors obsess over limit orders, trying to buy at exactly the right price. This gives them a feeling of precision and control. But in reality, they often miss good opportunities because the stock never hits their arbitrary price target. Or worse, a limit order triggers a purchase at a “good” price that then keeps falling.

4. Business success does not equal investment success. People who built successful companies or had great careers often think those skills transfer directly to investing. They believe they can “control” their investments the same way they controlled their businesses. But investing is fundamentally different. Corporate performance and economic conditions, not your intelligence or work ethic, determine most of your returns.

The Diversification Problem

Researcher Gerlinde Fellner at the Max Planck Institute specifically studied how the illusion of control affects portfolio diversification. Her findings confirm the problem: investors shift capital toward investments where they feel they have more control and away from investments where they don’t.

The practical result? Portfolios that are concentrated in familiar stocks and light on unfamiliar ones. This feels comfortable but it is the opposite of good investing practice.

What To Do About It

Pompian offers four pieces of advice.

Accept that investing is probabilistic. You do not control outcomes. Not with research, not with instinct, not with effort. Global capitalism is incredibly complex. Even the wisest investors have zero control over their investment results.

Recognize your triggers. If you are picking your own stocks, choosing your own entry points, and actively managing your portfolio, your brain is probably telling you that all this activity gives you control. It doesn’t. Correlation between your actions and market movements is mostly coincidence.

Seek contrary viewpoints. Before making any trade, ask yourself: what could go wrong? What are the downside risks? When will I sell? If you can’t answer these questions, your “control” is an illusion.

Keep records. Pompian mentions Peter Lynch here, the legendary Fidelity Magellan Fund manager. Lynch’s office was wall-to-wall research papers and notebooks. He documented every opinion and every rationale. When you write down why you are making an investment, you create accountability. You can look back and see whether your “control” was real or imagined.

I have managed IT systems for decades, and here is something that experience taught me. The systems I controlled most tightly were not the ones that performed best. The ones that performed best had good architecture, clear processes, and tolerance for things going wrong. The same principle applies to investing. You don’t need control. You need a good framework and the humility to accept that outcomes are mostly out of your hands.

Stop trying to control the market. Build a good portfolio, diversify, and let time do the work.

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Next: Hindsight Bias

This is part of a series retelling “Behavioral Finance and Wealth Management” by Michael M. Pompian. Start from the beginning.