Skill Sheet: What You Will Learn Here
- How greed and fear can affect trader behaviour
- How to manage these emotions to cut losses
Greed and fear are natural emotions. Both are important in the right measure. Too much fear can lead to inaction, while extreme greed can result in the wrong action.
Excessive fear can keep a person away from initiatives to explore opportunities and pursue them. On the other hand, excessive greed can lead to the neglect of pitfalls and threats that can result in foolhardy decisions. This holds true in the investment world, too.
Price discovery in the financial markets is the result of greed and fear. On many occasions, there have been wide swings in the markets based on many factors.
Geopolitical events like the Russia-Ukraine war, inflation, and the pandemic made the markets drop to crazy levels, triggering market circuit breakers, due to extreme fear.
There have also been times when the markets have been exuberant. In 2009, the United Progressive Alliance’s decisive win in the Lok Sabha elections ignited hopes of a stable government, lifting the benchmark stock indices to upper breakers twice.
Emotions drive the market
Emotions drive the market, leading to price moves. Broadly categorised as greed and fear, individuals and fund managers alike have given in to it.
Greed is a good motivator and a balanced measure can help in achieving various objectives. Greed can manifest itself in many ways and involves two things: not parting with what you have, and wanting more.
The lure of quick money in the markets is one of the fundamental greed factors. The dotcom boom was a period when expert investors and novices alike lapped up stocks of all dotcom companies.
Another industry that caught the fancy of investors was biotechnology. The mere addition of the suffix bio to a company name was enough to drive up the prices of their stocks.
The period 2000-2001, known as the dotcom bust, caused many investors to become bankrupt. They ignored fundamental analysis and basic investment guidelines in their pursuit of quick money.
Greed can cloud rational thinking by creating hope, which justifies holding a stock for higher profits. The risk of a sharp decline, in this case, can be high because securities get overpriced. It also mean waiting too long to make an entry, resulting in losing an opportunity.
Fear, on the other hand, is an emotion of losing what you have. This results in an investor selling early, anticipating that the market could crash. There is also the fear of missing out (FOMO) i.e., the regret of losing out on an opportunity and entering at a higher price. Fear is also manifested when prices fall steeply, resulting in panic selling.
Emotions and the markets are unpredictable. Controlling emotions is easier said than done. Having a plan in hand helps in such situations. One has to differentiate between being emotional and stubborn.
Planning helps in bringing objectivity and can keep emotions in check. It also helps to improve one’s knowledge about the markets. Getting educated in equity investments and strategies will go a long way in subduing emotions.