Greed and Fear – Keeping them at bay
Our primal instincts of fear and greed, according to Prof Albert Einstein, are two of the three great forces in the world. In case you are wondering about the third one, its stupidity. When these three forces come together in the stock-market, they can potentially spur irrationality to the highest degree in the stock market.
The harsh truth is that some things on hindsight would have seemed so obvious. But, during that particular time however, it made perfect sense as we get overwhelmed by our emotions as prudence and vigilance take a back-seat.
Hence, it is imperative that we understand the influence that fear and greed has on the average investor and by extension; the financial markets. Greed
We can get caught up in our desire to earn as much money as possible in the shortest timeframe. Where else to go to but the local stock market that has been rallying lately?
Fuelled by greed and emboldened by a strong market sentiment, it’s unlikely anyone would pass out an opportunity to make a quick buck in this market rally. Furthermore, it’s the fear of missing out that justifies the action of chasing a rising market.
Perhaps your friends just told you about a penny stock whose price is going to take-off in the next three months. Apparently he knows someone who is close to the major shareholders of the company, and that something is brewing in the company. Sounds familiar? Fear
When things start to take a turn for the worse, any negative rumours will spark a knee-jerk response and panic selling. It would not take much to further spook jittery nerves.
Here’s what could be going on as you struggle to comprehend the pace of the selling and at the same time, you are seeing your wealth plunging by the minute.
First, recency bias - The equity market is sliding by two to three per cent a day, the selling by investors doesn’t look like stopping anytime soon. In fact, they are just getting started. Second, herd behaviour – Everyone you talk with in the cafe or online forum on investment and trading are selling lock, stock and barrel.
Third, confirmation bias - Every news headlines, articles, and virtually everything you find on Google or what your friends share on Facebook, only seem to confirm to your own set of thinking. The combination of behavioural biases, a whirlwind of emotional responses and loss aversion eventually self-perpetuates into your ‘nightmare’ that everything truly is falling apart.
When a market sell-off happens, investors dump good and bad stocks alike. Investing basics and fundamentals are thrown off the window as everyone scrambles for the exit door. How can we keep greed and fear in check?
Keep your analysis and investment decisions objective. Be open to any opposing views and look at the subject matter from different perspectives.
Know why you have bought into a particular share, there has to be a valid reason and justification. If the underlying fundamentals and reason has not changed, ignore the market noise. Panic selling can even be an opportunity to add to that particular share.
Have a set rule or a disciplined process in your investment decision-making. A structured process helps to keep your emotions in check. Use strategies like portfolio rebalancing and cost or value averaging to your advantage.
Take a contrarian strategy, because at times, it can pay to be on the opposite side of the herd.
The legendary investing gurus, Warren Buffett and Sir John Templeton are two famous figures who remain in smaller towns/cities away from Wall Street to avoid the market noise, emotions and herd mentality. Don’t let emotions cloud your judgement. As what Buffett, the Oracle of Omaha famously stated - Be fearful when others are greedy, and greedy when others are fearful.