Recent market meltdowns and subsequent rebounds exposed the roles of greed and fear, the herd mentality and human psychology in global stock market action.
So far we’ve seen the S&P 500 decline from its high in the 1500s in October, 2007, to a low in the 600s in March, 2009, and then rocket to breach 1,000 by August, 2009.
Clearly greed and fear have been active players in this extreme market action and so it’s probably a good time to examine greed and fear and its role in trading today’s volatile markets.
And it’s important because successful investors understand their “humanness” and how to get their emotions to work for them instead of against them even during tough times like we’ve recently seen in the markets.
Bubbles are Nothing New
The Dutch had their tulips, Sir Isaac Newton was wiped out in the South Sea Trading Company’s meltdown in 1720, and we’ve had our own Black Monday in 1987 and the dot.com boom and bust just a few short years ago.
And now we’ve had our own version of “the end of the world” with the near collapse of the financial system and the subsequent Fed fueled recovery.
Greed is simple to understand. People want to make money. But fear is a little more complex in that there are really two types of fear: fear of loss, which we all understand, but also, fear of being left behind.
I believe a key to investment success is learning to control both your greed and your fear, and the solutions are the same for both.
Greed, Fear and the Herd
Everyone has heard about greed and fear being the two primary driving forces behind investor decisions. And that is true because, while much has been written about markets being rational and investors making rational decisions based on earnings reports, price earnings ratios or technical analysis, the fact is that markets are not rational, as witnessed most recently in 2008’s massive selloffs and 2009’s massive rally.
Greed and fear were at work.
And this has been seen time and again throughout history.
Investors Who Control their Greed and Fear Have a Better Chance to Win
Following the herd is a dangerous game and generally causes investors to lose money.
Most retail investors buy at the top and sell at the lows because they let the herd dictate their actions rather than trade with a logical plan and discipline.
Some ideas to help control the herd mentality are:
* Don’t overtrade. * Don’t take too much risk. * Don’t sell your winners too soon. * Don’t put your ego into your trading. * Keep your own counsel. The answers are not on the news or in the financial press. * Find a good plan and stick with it.
Most retail investors lose money in the markets because they let fear and greed, their emotions, interfere with their trading success.
While there can never be any guarantee of success, most investors find that understanding fear, greed and the herd mentality and then learning to manage their emotions can lead to better outcomes for their investing activity.
Disclaimer: All material herein is believed to be correct but its accuracy is not guaranteed. This article represents solely the opinions of John Nyaradi and readers are encouraged to consult their investment advisors prior to making any investment decisions. All information herein is for general informational purposes only. The information is of an impersonal nature and should not be construed as individualized advice or investment recommendations.
John Nyaradi is Publisher of Wall Street Sector Selector, an online newsletter specializing in sector rotation trading using Exchange Traded Funds.