psychology & Behavior
Greed and Fear
If you’re trading stocks, forex, indices, and so on, you probably heard about the Fear & Greed Index. The Fear & Greed Index is a market sentiment indicator developed by CNN Business in collaboration with Kamakura Risk Management. These two emotions—greed and fear—govern the sentiments of the players involved and impact the volatility and momentum of a certain instrument or the public perception of its value. Why is it important to understand this? Simple: in your finances and wealth building, whether trading in stocks or not, these two emotions will play a crucial part in your decision-making and sound investing.
Let’s take a closer look at Burton Malkiel’s, “A Random Walk Down Wall Street.
Malkiel used a hypothetical analogy about how a monkey throwing darts at a newspaper’s stock listings can sometimes pick stocks as well as or better than professional investors or funds that actively try to choose the best stocks.
30 years later, The Wall Street Journal tested this theory for real. They had a panel of experts select stocks they believed would perform well. At the same time, they had a blindfolded chimpanzee to throw darts at a list of stocks. The idea was to see whose picks would perform better over a period of time. The result was quite mind-boggling. The chimpanzee outperformed expert-chosen stocks.
It was quite a controversial experiment and a lot of experts have dipped their toes into analysing what went wrong, what they did right. But there’s a fundamental factor that is often overlooked: the behavioral aspect caused by fear and greed.
Fear and Greed Driving Financial Markets:
I switched my investing strategy to owning alternative assets over traditional financial instrument for this reason. The financial markets are volatile because of these two behaviors. People are fickled minded. A single tweet can over hype a stock or devalue it. These two behaviors are so dominant in the financial markets they had to make an index for it.
Our behavior and cognitive biases toward an investment are usually influenced by external factors like the news, public sentiment, and expert opinion. They create GREED also refered as FOMO to the public, and the next thing you know, the prices are falling – then people are fearful.
That’s why I don’t trust the media when it comes to choosing investments—it spikes greed, then fear, leading to losses. Take the dot-com bubble burst as an example. News and experts hyped rising tech companies, creating public optimism. Then, it only took a matter of time for the bubble to burst.
This scenario also occurs frequently in day trading. Many traders lose money because they anticipate a breakout (a stock or asset moving decisively in one direction after a period of consolidation), only to discover later that it was a fakeout or manipulation designed to trigger trades and then reverse. Trust me, I tried day trading but realized it wasn’t for me. Managing emotions in front of a chart proved to be challenging.
Fraudsters understand these dominant behaviors well.
You may recall Bernie Madoff, who orchestrated one of the largest Ponzi schemes in history. He promised investors high and consistent returns, claiming to achieve them through a sophisticated trading strategy. Instead of investing as promised, Madoff used new investors’ money to pay fake returns to earlier investors, knowing that high returns would attract more investors due to FOMO (fear of missing out).
Another example is Zeek Rewards, where participants bought bids for penny auctions, expecting a share of profits, but no such product or bids existed.
Then there’s the infamous Wolf of Wall Street (you probably watched the movie) His operation wasn’t a Ponzi scheme but a pump-and-dump. Belfort aggressively promoted penny stocks using high-pressure sales tactics and false information to artificially inflate prices. He and his associates sold their own shares at inflated prices before the stocks crashed, causing substantial losses to investors.
All these cases revolve around fear and greed, driving people to fall victim to financial fraud schemes.
The Irony of Fear and Greed
The irony of fear and greed in investing is clear: when you’re scared, you might hesitate and miss chances; but when you’re too eager for gains, you can end up losing. In the end, it’s true when they say that the game of money and success is 80% psychological and 20% technical.
So, how do we manage these behaviors?
- Understand the asset you are buying: Fear often stems from uncertainty and a lack of confidence in one’s ability to make the right decision. Building knowledge and gaining experience can help to reduce fear.
- The people behind an investment are crucial. That’s why I favor alternative assets—I can carefully assess and understand the individuals I’ll be collaborating with. Reviewing their track record gives me confidence that we can navigate the investment until it reaches its full potential. This approach helps me understand their motivations, which are often less clear in stock investing.
- For an investment to be worthwhile, it should meet a demand or serve specific needs. This involves understanding the business structure, how it generates income, and its ability to sustain profitability to achieve the targeted return on investment (ROI).
- It helps me sleep well at night, knowing my investments are diversified.
- Set realistic expectations: the aim is to generate long-term returns. Speculative investing is challenging—even banks with extensive resources and manpower often lose in speculative trading. It’s wiser to focus on long-term goals. While it may not be flashy, it’s a steady path to building wealth.
As a reminder, fear and greed are intrinsic to human nature. You can’t simply put on a poker face and claim to be devoid of either, but you can learn to manage them. The first step is awareness. Now that you are aware, it’s time to create your investing fundamentals and criteria.