Fear and greed are two of the most common emotions influencing decision making on the stock market. Fear can lead to panic selling when markets decline, and greed leads to buying overheated stocks with the expectation of continued rapid gain. In this article I will analyze how fear and greed influences people’s actions on the stock market, so you can avoid these mistakes, when you are investing.
The role of fear in investing
The phenomenon that happens, when the stock market is controlled by fear is called the herd behavior. It is called that, because when the market starts to decline, investors start to panic and sell their stocks, that leads to more panic and even more price dropping, so more investors start to sell, thus following the herd.
Fear induced decision making is for example panic selling, when the markets decline, and investors are afraid of losing money, so they sell all their assets at a low price. Another one is loss aversion, when investors are afraid of losing money, so they exit the market prematurely or miss out on potential market recoveries, to avoid risks.
If following the herd, i.e. selling is the worst thing you can do when the market is declining, what should you do instead? Don’t act impulsively, hold onto your stocks, until the market recovers.
The role of greed in investing
Some may say that greed is essential to make a good portfolio, and to not be afraid of taking risks. However, when people want more and more, that can lead to bad investment decisions and a loss of money. Greed might not make us panic and go into a quick decision blindly, but it comes with impulsive stock buying or selling just as fear does.
Greed induced decision making can result in buying high, meaning investors buy already overvalued stocks in hope of quick and high profit. Being greedy also can result in investors being overly confident, therefore taking higher risks, and believing that their success and gains will continue forever.
Greed can also lead to herd behavior, which you should not follow, when thinking about buying or selling stocks. In this case you should make informed and well analyzed decisions as well.
How to overcome emotional investing?
- Be aware of your emotional decision making and try to catch it in time
- Learn from your previous mistakes, but don’t let them hold you back.
- Even if you are successful, don’t be overly confident.
- Define your goals
- Identifying your goals before you start investing can help to keep you on the right track even through the harder times.
- Define your time horizon
- Use the bucketing approach to divide your financial goals into three groups, short-term, intermediate-term, and long-term.
- Diversification
- Spread risks across different asset classes.
- Make your portfolio as divers as possible, by investing in both high and low risk stocks.
- Consulting with professionals
- Professionals can give you emotion free advice of your investments any time.
Which emotion is dominant on the stock market right now?
As of October 2024, according to CNN’s analysis the dominant emotion on the stock market is greed, almost reaches extreme greed. This means, that the market is doing well, and investors are overly confident, so they may take higher risks.
Conclusion
Fear and greed were always a part of the operation of the stock market, and it always will be. But when investors are aware of this and know how to control their emotions when making their portfolio and when the market falls, that can be a huge advantage.
To create the best environment for emotion free investing, set your financial goals and your time horizon, make a diverse portfolio, discuss your investment strategies with a professional, and most importantly don’t follow the herd.
References
Investopedia: Financial Markets: When Fear and Greed Take Over