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Greed and Fear
The Smart Profits Report: Issue #406
Monday, March 26, 2007
Greed & Fear: Gauge The Fear And Greed Factor To Boost Your Investment Success
By Mark Whistler
Small-Caps Specialist, Mt. Vernon Research
Greed and fear.
Two very powerful emotions that, when applied to investing, are two main factors that drive the stock market. Or so the old adage goes. To a large extent, the emotions of greed and fear do drive the buying and selling actions of investors, traders, hedge funds and institutions.
The fear aspect comes from investors who sell because they’re afraid of giving up gains in an existing trade, or simply afraid to lose money at all. But fear also triggers greed. The fear of missing out on gains and the desire to increase wealth and grab profitable opportunities while they exist is a powerful emotion.
But emotions are tricky - no matter who you are. And when your hard-earned money is riding on the emotions of millions of others, the situation can become even more complicated.
However, as I’m about to show you, this doesn’t have to be the case - and once you see the true “emotion of the market,” you’ll become a savvier, more intuitive investor. Let’s see how…
Why Greed Is Actually Fear In Disguise
Greed is generally defined as an urge to obtain substantially more than an individual needs. But really, greed is a manifestation of fear - the fear that you won’t get enough of something that you want.
A major motivation is that when people dream of having an abundance of wealth, they think they’ll be free of worries. For example, if you know you have one million dollars stashed away, you have no more worries about paying the mortgage. But the only way to amass such a large amount of money is to build wealth.
And because most people don’t want to feel fear, the greed can kick in as a way to overthrow it.
In the investment world, it boils down to this:
- When buyers are coveting stocks, their greed is really fear in disguise.
- Buyers are afraid that if they don’t get in, they will miss the chance to be in a stock that’s going up.
- And if the opportunity is missed, abundant wealth will not be gained.
Google (Nasdaq: GOOG) is a great example of this. There are thousands of people who didn’t invest in the stock because they believed it was overbought and primed to fall back. But the stock defied the odds and rose another couple hundred dollars. It was the fear of not being along for the ride that prompted investors to drive the stock higher and higher.
So what do you do when you’re sitting on the sidelines, watching the stock market or a company rise quickly? And how do you combat being caught in a falling stock? Let’s see…
How Understanding Fear Can Help You Combat A Losing Trade
If you’re holding a stock that is dropping, take a step back and ask yourself two key questions:
- How worried am I about losing a lot of money?
- How fearful is the rest of the market over the stock’s prospects? (You can get an idea by looking at the volatility level on the stock’s options - a subject we’ve discussed in this column before).
In posing these questions, you can not only evaluate your own tolerance to risk, but also the market’s perception.
For example, if you can stand to lose a little on the trade, and the broader market sentiment doesn’t think the stock is going to plunge overnight, you can probably hold the position for a little longer (as long as it hasn’t hit your pre-determined stop-loss point, of course).
What you’re essentially doing is stepping away from the market and making a decision based on the perceived fear of the broader market.
To Buy Or Not To Buy? Gauging The Greed Factor
So what about situations like the Google example I mentioned a moment ago? If you’re thinking about purchasing a rising stock in a rapidly ascending market, there is obviously greed factoring into your desire to make money.
But more importantly, there’s a good chance that you’re also fearful that the market and stock will go further without you being on board for the ride, if you don’t get in now.
Again, when weighing your decision whether to buy, step back and ask yourself two questions:
- How fearful am I of missing this opportunity to make money?
- How fearful is the rest of the market about missing this opportunity?
If you conclude that the rest of the market could be equally fearful of missing the opportunity, you’re using market momentum and sentiment to rationalize your decision. And momentum and sentiment are two pretty powerful forces.
It’s important to remember that gauging the market’s emotions when making investment decisions should be done in tandem with fundamental and technical research.
By doing so, you’re able to not only crunch the numbers, but also evaluate other influential events, and make a clearer decision for more profitable trades.
Good investing,
Mark Whistler
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Today’s Smart Profits Cribsheet
- After a 7-month market rally from July 2006 to February 2007 that saw stocks barely pause for breath (the biggest pullback was just 2%), volatility is now back in the market with a vengeance. Investors are more nervous, which means higher levels of fear and greed. A great way to gauge the mood of the market and investor sentiment is to look at the CBOE Volatility Index - commonly known as the VIX. This index measures the level of fear or complacency in the market, and is a valuable tool that helps you pinpoint the best time to buy and sell.
- Despite the mass of fundamental, technical, and quantitative research tools available to investors these days, it’s an undeniable fact that basic human emotions play a huge part in the behavior of the market and stocks, too. You have two choices. You can either let the emotions of others dictate the way you trade in a negative way… or you can use emotions like fear and greed to your own profitable advantage. To help you achieve the latter, an elite group of professional traders, investors and money managers have written the ultimate investing guide - including a section on “how human emotions can drive stock market prices.” These 31 proven “secrets of the masters” will give you a critical edge over the investment crowd, showing you the tips and wealth-building strategies you need for success. Follow this link and harness the power of 480 years of expertise today.
- As a successful licensed trader for over a decade, Mark Whistler is well-qualified to pass on the skills you need to trade confidently and profitably in an increasingly popular, but volatile, market climate. Having worked with some of the most respected traders in the world, Mark has built up an impressive level of expertise, and honed the professional investment strategies that allow you to make the most money in the fastest time. In his second book, Trade With Passion And Purpose, Mark outlines the qualities that separate ordinary investors from the top traders. This includes not just subject-specific knowledge, but also the core psychological, philosophical, personal and emotional strengths that will help you overcome stress and setbacks and improve your chances of success. For more information, please visit this link.
Related Articles:
- Investing In The Fear Effect: How To Buy Bargain Stocks When There’s Blood In The Streets
- The Market Volatility Index: Using The VIX To Straddle And Strangle Stock Options
- Sentiment Analysis: Incorporating Contrarian Investing in Your Trading & Financial Endeavors
- Investor Sentiment & Market Behavior: Seven Tips For A Profitable Downside Bias
