When Overconfident Traders Meet Feedback Traders

We develop a model in which informed overconfident market participants and informed rational speculators trade against trend-chasers. In this model positive feedback traders act as Computer Based Trading (CBT) and lead to positive feedback loops. In line with empirical findings we find a positive relationship between the volatility of prices and the size of the price reversal. The presence of positive feedback traders leads to a higher degree of trading activity by both types of informed traders. Overconfidence can lead to less price volatility and more efficient prices. Moreover, overconfident traders may be better off than their rational counterparts