The stock market prices are the reflections of the collective investment behaviour of all the investors. The investor’s emotions of “greed and fear” are contagious in nature and are responsible for the towering highs in the bull market and subsequent crash.
By Lakhwinder Kaur Dhillon
Fear and Greed are two very strong primal and instinctual emotions and they are the driving force of stock market movements. The stock market prices are the reflections of collective investment behaviour of all the investors. The investor’s emotions of “greed and fear” are contagious in nature and are responsible for the towering highs in bull market and subsequent crash.
These two emotions are the actual representation of two sides of investment risk as greed represents ready to take higher risk while fear represents appropriate management of risk by recognising it. Being calm when prices are falling and controlled when the prices are soaring heights is not an easy task for an investor. Whether a new investor or a seasoned veteran, one constantly battles these two emotions. But if one understands when to embrace or tame these emotions, a strong position can be created in meeting the financial goals.
Greed and the investor
When stock prices are showing upward trends, more and more investors get involved in buying the stocks. As the stock market is governed by the principle of law of demand and is a reflection of investor behaviour, the result is dizzying high in the bull market. High prices instigate the investor to make more profits and growing profits fuels more greed. With high demand, prices keep rising further and so does the profit. Investors get involved in booking short-term profits.
At a very high level of prices, bubbles get created and as the intrinsic value of stocks are much lower than the market price, eventually the bubble burst and price crashes. Investors who buy stocks at very high prices following the aggression of the growing prices (bullish trend) in the market suffer huge losses due to the crash in the market.
Fear and the investor
When the stock market goes through the process of correction due to overpricing in the stocks, a downward trend in prices is witnessed. In a falling market (bearish trend), investors get into a panic selling mode due to their apprehension that the market will fall further, and the consequence is a sharp fall in the share prices. Investors’ fear of losing all their investment in the falling market leads to aggressive selling and as the stock market is governed by the principle of demand and supply, the market falls further.
Two to three years’ rise in share prices can get wiped out in just two to three months of a bearish trend. When markets are rising everyone wants to become rich by booking profit and get involved in buying. In a falling market, everyone starts selling to minimise their losses due to apprehension of a further fall in the market. Legendary investor Warren Buffet says, “Be greedy when others are fearful and fearful when others are greedy.” According to him, “no one wants to get rich slowly”. The contagious disease of “Greed and Fear” becomes a mammoth obstruction in the long-term goal of wealth creation.
Strategies to tackle greed & fear
Market sentiments cannot be controlled but one can control one’s own actions. So, understand the fundamentals behind your investment plan, stick to your investment plan and avoid spontaneous decisions looking at the general uptrend or downward trend of the market. Respond to the market with reasoning and base your decision on logical and rational principles.
Do not fear the risk of losing your money in the short term. Rather, be focused on the long-term gains based on the view of the company and economic conditions. Rationalise your decisions based on available information rather than being guided by greed and fear.
The writer is faculty, Amity Business School, Amity University