Understanding "Buy Fear" and "Sell Greed"

Oct 18, 2023 By Susan Kelly

Warren Buffett said, "Investors would be advised to "be materialistic when others are afraid, and fearful when others are materialistic."

There is a maxim on Wall Street that only 2 emotions, fear & greed, can drive the market. However, even if this is overgeneralized, it is mostly true. But these two emotions can also have serious negative effects on portfolios of investors, the stock market’s stability, and even the whole economy. Understanding market psychology is a subject that has generated extensive academic literature known as behavioral finance.

If stock market investors are using the Fear & Greed Index, they must keep an eye out for strong currents of fear and, when they strike, look for undervalued companies. If they stick with it for the long haul, they may find some amazing investment possibilities that might otherwise go unnoticed.

Below, we address fear and greed trading strategy and explain what occurs when these two feelings become the deciding factors for small investors.

Influence of Fear: When Investors are Buying

Suppose you buy equities when investors are most fearful and when shareholders are dumping stock mostly out of fear. In that case, you can uniquely position yourself to acquire those identical shares for a far lower price.

Investors may start selling their equities when stocks experience significant losses over an extended time for fear of more losses. Naturally, this leads to a self-fulfilling cycle where prices continue to decline. Herd behavior is the term economists use to describe what occurs when investors purchase or sell simply because others are doing it.

Like greed rules during a boom, fear rules the market after a boom's fall. Investors immediately sell stocks in order to reduce losses and purchase safer assets, such as stable value funds, money market securities, and principal-protected funds, which are all low-risk but low-return investments.

The fear will Fade over Time

The fear in the market will pass, just like everything else does, with time. Businesses will restore their confidence. Significantly undervalued shares (sold off during a period of capitulation) may begin to rise in the medium term (perhaps over the next few months) toward more reasonable, considerably less frightful pricing.

Influence of Greed: When Investors are selling

Smart investors who have bought the fear must find the most opportune moment to sell the greed.

Typically, shares whose prices have been rising cause greed. The equities you purchased after investors sold them off in fear will unavoidably draw the curious gazes of investors who are watching them recover to their proper valuations and perhaps even beyond.

Bull markets encourage most people to become wealthy as soon as feasible as they desire. A prime example is the late 1990s internet boom. At the time, it appeared like all a financial advisor needed to do to attract investors was to suggest any investment that ended in ".com." Investors became excessively greedy, driving up prices by continued buying and bidding to unwarranted levels. It finally burst, reducing stock values from 2000 to 2002, just like many other financial bubbles throughout history.

As Gordon Gekko, a financial investor, famously remarked in the film Wall Street, Greed is great. It is challenging to maintain a focused, long-term investing plan, though, particularly in the midst of what Alan Greenspan, former Federal Reserve Chair, dubbed "irrational exuberance," as he put it.

The Hope for Even Greater Gains

The absurdity of greed is that it has no end. The shareholders become pleased and expectant that they may get a 150 percent profit if the shares increase by 100%. The same shareholders will demand 200 percent if the price at which they purchased the shares rises to 150 percent of that amount. Most investors are hoping for even bigger returns rather than profit-taking chances.

Investors sitting on a very sizable profit start alerting their friends once an investment has begun to move upward. As more people become interested after hearing about the significant investment rewards, the prices rise even further.

More greed will be attracted to the shares as they rise in value. Greed, nevertheless, will not assist you in creating a long-term, dependable, and prosperous investing strategy. Instead, it commits many investors to the expectation of profiting even after the price has increased above reasonable estimates. They risk holding onto those shares for too long and possibly even seeing a fast loss in value once the price drops again.

Don't let Greed Cloud your Judgment

Investors need to understand that, like air, greed is something we all have. Although it can't be seen and impacts every moment of our life, nobody pays attention. Therefore, greed can impair judgment and cause people to cling to some stocks for longer than they should. Because of this, the six seemingly straightforward words "Buy the fear, sell the greed" are effective financial strategies. This phrase advises all investors based on the wisdom of years of investment experience and expertise, which may be used to help you in deciding whether to buy or sell.

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