Greed and fear are widespread among investors. As a long-term thinking investor, you should not let other people’s emotions affect you but simply stick to your investment style, which is not always easy. Especially in phases of greed and fear, it can be challenging to remain rational — time to take a closer look at these dangerous emotions.
Investors Key Takeaway
- Greed and fear are the driving forces of the stock market. These phases mark the regular cycles of bull and bear markets.
- Phases of greed and fear reflect investors’ mood poles and impressively show that the market and its participants follow emotional trends. You can recognize the phases by the different narratives that prevail in each phase. While these narratives don’t give you a guarantee or a way to time the market, you should still be able to identify these phases to stay immune to the emotions.
- As a long-term investor and generally speaking, you should not be influenced by your fear or greed. Just keep investing. Live your life and watch from the sidelines as other investors go crazy.
- Being guided by emotions leads to cognitive misconceptions, and cognitive misconceptions lead to mistakes. However, you shouldn’t make any mistakes, especially when it comes to investing and wealth management. You don’t have to be spot on all the time. It’s enough if you don’t make the wrong decisions.
Fear And Greed
Fear and greed are the two poles in investors’ mood, which is closely related to the fact that investors, like all other people, are emotional beings. Even if many investors or traders see it differently, hardly any of them are likely to act 100 percent rationally. And so it happens that the waves of emotion spill over the stock markets and swirl prices up and down like a small bowl. As long as there are stock markets, you can observe such phases.
Phases of greed
First, there are the typical phases of greed, which usually lead to exaggerations and highly overvalued companies. Such exaggerations can go so far as to create valuation bubbles. In such phases, companies’ intrinsic value is decoupled from the purchase prices and significantly lower, e.g., for companies that show annual growth of 10 percent, the share price grows 15 or 20 percent per year. There is a focus on opportunities. Possible losses, risks, or downside scenarios are not evaluated.
These phases are characterized by certain narratives, which can help identify greed. Such widespread narratives may include:
- “This time, everything is different.”
- “The comparison to other bubbles does not fit.”
- A high degree of optimism.
- “There is still a lot of potential.”
- “Company A or B is disruptive.”
- “Multiples like P/E ratio etc., are no longer relevant today (this time, everything is different).”
- “The skeptics don’t understand the stock markets, or they have gone short.”
These narratives are only examples, and they are not proof of such a phase of greed. However, it is also noticeable that those narratives are prevalent in phases, in which the markets rise enormously and reach one all-time high after another. Market participants are becoming reckless here and assume that the momentum of rising prices will continue, which attracts more and more investors. Everywhere people are now talking about share X Y, which has made so many people rich. You see the greed in the eyes of the investors. Everyone wants to participate and earn their share.
Phases of fear
Then there are periods of fear and anxiety. In phases of fear, the sentiment changes completely. Investors are suddenly afraid of losses. They become extraordinarily risk-averse and pull their money out of the stock markets. Here, too, individual narratives prevail in times of fear:
- “This is just the beginning. The worst is yet to come.”
- “A stock that falls 90 percent can fall another 90 percent.”
- “The stock markets are a casino.”
- “I prefer to wait for the bottom before investing.”
- “I don’t think we’ll see the old all-time highs again for the next 10, 15 years.”
Economic crises often occur during such phases. The profits and losses of companies collapse. It looks like everything is only going to get worse. Suppose they do, only the incredibly courageous invest such as institutional investors. In such phases, private investors, in particular, tend to remain on the sidelines.
Phases of greed and fear ultimately mark the cycle of bull and bear markets
These two phases ultimately mark the cycle of bull and bear markets. Ever since stock markets have existed, history has been marked by such cycles. It is usual for assets like stocks or real estate to go through periods of fear-driven undervaluation or greed-based overvaluation.
Why you should be able to identify such phases
Even if narratives give you an indication of greed or fear, they don’t help you time the market. Nevertheless, it is worthwhile if you can read the market sentiment correctly. It protects you from unconsciously becoming a slave to the emotion-driven herd.
I’ll give you an example: Let’s assume a stock has increased by 300 or even 400 percent within a few months and has a market capitalization of USD 20 billion. However, the company is not yet generating any revenues but is looking for a way to develop efficient batteries for electric cars. The share price continues to rise and rise, although the company itself points out that it has no guarantee that it will even develop such batteries. The hype is endless. Everyone sees the company as a disrupter that will turn the entire industry upside down. What do we see here?:
- We see investors betting, not investing. The share in the company becomes a speculative object, a betting slip.
- Investors invest because of a vision, not because of a working business model. Fundamental parameters do not play a role. Success is anticipated; failure is ignored.
Such an environment can be extremely contagious. You see how your neighbor, who never had anything to do with stock markets, earns a lot of money within a short time. If you don’t know the narratives, you don’t see the dangers of a possible bubble. You quickly start gambling and become part of the problem. Therefore, you should always be able to recognize greed (or fear). I’ll show you the best way to deal with such phases further below.
Fear and greed are only two sides of the same page
In the end, every bubble is the result of excessive greed and ends with extreme fear. However, greed and fear are connected and even mutually dependent. In the end, greed and fear are just two sides of the same page.
Fear of missing out
From a human perspective, greed is often the fear of missing something that others may get. You may know the so-called FOMO (fear of missing out). In the years of the first cryptocurrency hype (2016-2018), I have seen how other people invested in Bitcoins just because they saw how others got rich from it. I know other people who started to buy Bitcoins because they were afraid that their friends would make a big profit and they might miss that.
“I only bought bitcoins because I didn’t want to be upset later that I didn’t do it.”
Once you hear a sentence like that about an asset class, you should think about whether you could live with a crash of that asset class. But since Bitcoin appeared to be quite expensive back then, people then invested in some other cryptocurrencies. It was absurd. It was all about quick wealth. Greed ruled. But then, they saw what happens when greed meets fear. In the end, the cryptocurrency crash of 2018 was more severe than the bursting of the dot.com bubble. In some cases, the currencies have fallen by over 80 percent.
Fear is also only a form of greed
Fear is also only a form of greed. Greedy people are afraid of losing what they have. And the more you have, the more scared and worried you are about losing it. It’s a vicious circle. I find it fascinating how closely these two emotions are related when it comes to investing.
How to get rid of your emotions
Greed and fear are typical characteristics of investors who act based on emotions, which is quite dangerous for stock markets, the economy, and thus for everyone’s prosperity.
Remain optimistic for the future …
You know the markets can crash badly. But you also know that they always rise in the end. As long as your companies grow in the long-term, everything will be okay in the end. And guess what? In the long run, our world has moved on after every crisis. There are companies whose roots go back centuries and have survived numerous crises.
You can even use a market crash to lay the foundation for future prosperity. So there is no reason to be fearful. But don’t be too greedy, either! Just make sure you never invest money you’re going to need for the next ten years. Always be liquid, so you do not have to sell your shares in emergencies when they have just fallen in price.
So free yourself from your fears of losses when you invest in the stock market. See your stocks for what they are: Participating interests in companies. You are the owner of these excellent companies. People go to work for you every day. You profit from success, and you suffer when things go wrong. That’s life.
… but assume that it could crash at any time
Nevertheless, it helps to visualize that a crash can happen at any time. You must accept that your shares could be worth 40 or 50 percent less within a short period. It helps to imagine and visualize such a situation. Then when it occurs, it hits you less hard. Sounds crazy? But it is true. Such a mental confrontation also helps in anxiety therapy, such as exam anxiety or general nervousness.
Investing is not a competition
Don’t get upset about missed opportunities. Investing is not a competition. It is wealth management. In another article, I wrote the following, which also fits very well here:
If the train now runs without me like Tesla or Microsoft, that’s the way it is. I do not lose anything through this. If I were continuously annoyed about missed opportunities, I would be upset about not having guessed the last lotto numbers correctly (I don’t play lotto, but I would if I knew the right numbers in advance 😉 ). Investing is not a competition for me. I invest in companies because I want to own them, not because I believe their share price could double immediately (that would be great, but no one can know that beforehand).
I check what value I get for what price.
The most critical point for me is that I always check what value I get for a price. If you have a proper strategy here, you automatically avoid the bubbles. Why should I invest in a company that has no cash flow and no profit? No thanks, I’ll pass. Why should I pay USD 100 for a share if the company only makes USD 2 profit per share, and I have to wait 50 years until this share has financed my investment with the profit? No thanks, I’ll pass.
Oh, look, there’s a crisis. A company with a stable and profitable business model and decent revenues pays a cash flow backed dividend of USD 6 per share and has earnings of USD 12 per share. Six months ago, the share cost USD 200. Now there is an economic crisis, no one is buying shares, everyone is scared, and the share only costs USD 100. Well, well, well, now we’re getting down to business.
So it’s all about fundamental metrics. I also like to call it a “commercial approach”. I want to make a living from my companies, and that’s only possible if their earnings and cash flows are in reasonable proportion to the purchase price. That’s all.
It’s relatively simple, yet so hard, especially in times of greed or fear.
In this sense, I wish you the very best,
TEV
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