Understanding the Effects of Fear and Greed on the Stock Market

Greed causes ‘irrational exuberance’. Fear is the cause of greed. These two emotions are causes for the ups and downs of the stock market. Whenever there is up, there will be down. A stock market can never be in a bull run due to greed and fear.

Greed and fear is dependant on the market sentimental. When the market is good, investors and trader would continue to buy up a share even when it is overvalued or has risen for a few days by a great percentage. When this happened, the stock become a musical chair where the last greedy man who carry the baby would have to suffer loses when everyone else take their profit.

I have experienced greed and fear when trading the market. I thought that I was never a greedy person and not fearful of it. But I was totally wrong. When a stock runs up, chasing to buy it is a common mistake done by many. To tell you the truth, it is highly manipulated by the invisible hand. Consolidation usually takes place before a stock runs up and when it runs high enough, the manipulators let go of it by selling high to you. Thus you lose out due to greed.

The sub-prime crisis in 2007 causes a series of corrections in February, August, November and January or 2008. When will this end? No one knows for sure. What I experienced during this period of trading in the stock market is fear. All rebounds are short live. Whenever a stock goes up, it tumbles down fast due to profit taking. Everyone is afraid of losing their capital. There is not much volatility in the stock market during period of fear.

The periods when you can see the fear coming into play is when the stock market is over-valued and with a great number of investors holding on to stocks due to greed. When a super bad news like going into recession come into play, you can see clearly how fear can affect the stock market badly. There is no such thing as a good stock to hold. No stock is spared. Another period is when the bullish investors still unwilling to let go of their holdings after a first correction when the trend turns bearish. When all hopes are dead, another series of selling down with fear set in. This time is the lost of hopes.

Fear. In my own opinion, this has a greater effect on the market. Even when the economy looks good, when the unknown unknowns are there, anticipation of the stock market to crash is high. As soon as the news of the unknown unknowns is released with more than what everyone else expected, everyone rushed to sell. Some who hold on due to ego were forced to sell in the end due to the fear of losing even more. It is a dominant effect.

Hence, a positive player could make use of this to short the market. You may be surprised by how much he could earn if he short at the start of a bear trend. Usually a trend would last at least three months or so. And a correction is at least three weeks.

Greed can push a stock market higher and higher, while fear can pull the stock market lower and lower into a bear territory. Good things never last, worst can only get better.

A wise saying is, “Buy into fear, and sell into greed”. Understand the emotion, control your own, you can thus control the market. You need to be emotionless and rational to do this.