Learn something new every day
More Info... by email
Greed and fear are important concepts in the world of investing. Some financial experts believe that markets can be strongly influenced by these two emotions in relation to macroeconomics. According to popular theories, greed is related to the impulse to buy stock or shares, while fear is related to the impulse to sell. Greed and fear also come into play with bear and bull markets, where greed is linked to a bear market and fear to a bull.
Greed and fear, together with a herd instinct, are often blamed for cycles of market bubbles. A bubble occurs when investments in a particular area of the market go through a sudden surge, leading to equity often far above realistic values. In the 1990s, the financial market experienced a bubble in Internet investing, now known as the dot-com crisis. Driven by greed, or a desire to make as much profit as possible in as short an interval as manageable, investments in Internet start-ups soared massively throughout the 1990s.
The bursting of the dot-com bubble in the early 2000s may have been partially motivated by fear, as investors realized the extension of equity above value and began to sell before prices could drop. These sales may have lead to a herd instinct to sell, which grew more motivated by fear as it became clear to more investors that the bottom had dropped out of the whole market segment. In effect, the fear of a bubble burst may have contributed to the bubble bursting, leading to sudden drops instead of a more steady decline over time.
Fear can also lead to a change in investment strategy that is unwarranted by the market. Many people, gripped with the apprehension of a coming crash, will switch investments into low-risk, low-return investments. While this may not sound particularly dangerous, the investor risks losing potential earnings should an emotional impulse be incorrect. Earnings losses motivated by fear can sometimes end up being just as costly as asset losses motivated by greed.
Market experts generally recommend that traders set up strategies little influenced by greed and fear. While it may be more exhilarating to use emotional intuition as basis for stock trading, it is usually considered far more profitable in the long run to divorce trading decisions from emotion. Some of the world's best investors remain in the black by doggedly sticking to their trading strategy when greed and fear grip the market. While this certainly carries its own dangers, a truly successful investment strategy is able to manage small gains or small losses and still end up profitable.
Hersch Shefrin wrote a book called, "Beyond Greed and Fear," in 2007 that deals with decision-making and psychology in finance, and many universities have either classes or programs addressing the psychology of financial decision making, but I wonder what specifically can be done to avoid making rash financial decisions. Are there behavioral techniques that someone can use?
One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days. Thank you for helping to improve wiseGEEK!