Financial markets are driven by two powerful emotions – Greed and Fear. Let’s delve further into “greed”, its impact on us and how we can manage and make use of it.
Many associate signs of greed with:
- Get rich fast
- Leverage
- Speculative investments
- Attractive returns investments that are too good to be true
- High concentration
- Go for big profits
Greed exists as an emotional state than in form and it is more of how we manage our desire. Many experienced investors and traders do one or more of the above and have been successful with their strategies.
What is greed?
Greed is the selfish and excessive desire for more of something (such as money) than is needed. It is wanting more and more; as much as possible. Greed impairs our judgment and rationality to make sound business decisions because it causes us to focus on our desire to want more.
Greed can start with (a) our intention: to get rich fast, to buy a car and house, to pay debts or to secure our retirement and/or (b) Fear-Of-Missing-Out, seeing opportunities of attractive returns. We see investing/trading as the means to achieve our needs and wants.
Dimensions of greed
Measuring greed
Greed is not binary: Am I or am I not greedy? It is more of magnitude: How greedy am I? How much of my money is funding my greed?
We look at the magnitude of greed in three aspects:
- the degree of the desire to keep buying more and more at a higher and higher price (i.e. chasing)
- the degree of the desire to keep holding to hope for a higher and higher price
- the extent of our allocation to make more and more to desire to buy more and holding
When all three of the above-mentioned happens, risk (possibility of loss) increases significantly.
I am ambitious and opportunistic; I am not greedy.
Few admit that they themselves are greedy and how greed they have become. The word ‘greed’ is reserved for others, not ourselves. We self-justify that we are being ambitious and opportunistic and not greedy. We avoid reflecting on the extent of our greed we are into and the consequences. We believe we have self-control and manage well; all will end profitably.
Jeff Bezos: “Your investment thesis is so simple…you’re the second richest guy in the world, and it’s so simple. Why doesn’t everyone just copy you?”
Warren Buffett: ”Because nobody wants to get rich slow.”
What Warren Buffet said is the essence of greed in investment behaviour. Investors want to make profits quickly. The bull markets provide the opportunity to make profits in a short period of time.
Here are some subtle signs of greed:
- Checking share prices frequently
- Checking profits frequently
- Keep breaking investing/trading rules:
– Being drawn into buying more risky, speculative and hyped/hot stocks
– Going for leverage
– Keep adding more risky and speculative stocks
– Keep holding and hoping it goes higher (and higher) with no clear endgame - Daydreaming of future profits and what we can do with the money
- Excited about the upside (profits) and not thinking about the downside (losses)
- More moonshots and bullish posts on social media
- Being tunnel vision with affirmation and confirmation biases without considering alternative views
- Having friends approaching for investing ideas (tips) — a sign of greed spreading
- Extent of the disregard for valuation
Greed needs not to be about using leverage or buying speculative stocks. It can be buying alot of blue chips at a high price late in the rally or buying alot of unfamiliar “attractive” investments.
Magnitude of rally = The more greed grows and spreads
Stock market prices reflect the collective investment behaviour of all investors. As the market keeps rallying, making money becomes easy. The rally fuels greed to grow and spread.
- Investors/traders begin to buy more; hoping to make even more.
- New market participants are attracted to the market and start buying.
- Everyone are buying at a higher and higher price and hoping for even higher prices.
As the market rallying, people will start noticing and getting interested, creating a bandwagon effect. Many believe it is an opportunity to make a good sum of money; to get rich quickly. As the rally gets hot, it is time for moonshots! Our tickets to financial freedom! We begin to give excuses to loosen our disciplined investing rules and investing and risk management plans. With lots of profits with the rally, we make no ‘mistakes’.
We begin to feel smart and complacent. There are lots of excitements and interests for the rally. There is no consideration for intrinsic value and fundamentals. We want to make more and more. We keep adding and the average cost keeps going up. Worse, if we keep much more as the price goes higher up, it will bring the average cost much higher. More worse, they did not sell because they want to go higher to earn more. They may have sold but it has shot up much higher. As we put more money into the rally, some decide to go into leverage. Greed fuels the rally, the rally fuels more greed — it is a self-feeding frenzied cycle. We believe we are being opportunistic. We believe that we can manage well and take profits before the rally is over. We will not be the last fool; there will be a greater fool buying from us (the Greater Fool theory). Greed has numbed our rationality.
The markets get more overvalued (above historical averages) and become unsustainable. Some bad news will eventually burst the rally. As the market pullback and crashes, greed can be so strong that we do not believe it is the end of the rally; it is a pullback and it will go up again. As there is a lot of leverage with a huge rally of speculative stocks, the pullback can be fast and hard on our profits; losses can happen too.
“Greed makes man blind and foolish, and makes him an easy prey for death.”
Rumi
Rallies can be fast and furious. A hyped rally caused by frenziness and greed; rrational exuberance. It was a phrase used by the then-Federal Reserve Board chairman, Alan Greenspan during the dot-com bubble of the 1990s. It was interpreted as a warning that the stock market might be overvalued.
Greed is hoping to turn $1,000 into $100,000. As the market rallies, greed grows. We keep buying more and more money hoping to turn $10,000 into $500,000. Many end up blowing up more than the capital. We believe we can manage and control our greed and profit from the rally but the reality is that we can succumb to greed.
When money is good and people get greedy, delusion takes over and rationality edges out.
The Lifecycle of Greed and Fear by Morgan Housel
The pullback and losses will turn greed into fear. The exhibit below details the emotional ride through a market cycle.
Managing greed
The financial market ebbs and flows in varying magnitudes. Greed is part of us and part of the financial market. We cannot control the market. We can easily feel greedy especially when the rally looks like an easy money ride. We have to manage and control ourselves through various indicators, investing/trading rules and processes. We need to incorporate greed-counteracting features into our investing/trading process. For me, these include:
- Be conscious of the signs of greed mentioned above
- Check weekly and monthly RSI and MACD on the extent of oversold
- Focus on what we know and understand
- Check the price-earnings ratios of indices and key stocks to ensure that they are within the historical averages
- Check the Greed and Fear Index
- Be strict on allocation
- Set strict rules for taking profits and cutting losses
Knowledge is the antidote to greed and fear. Investing without much knowledge with a significant percentage of money is risky and greedy. Continue to learn about investing/trading. Continue to improve our processes and strategies; be strict with the process when investing/trading. Knowledge, skills and experience build confidence and conviction.
Be aware of our greed and emotions. Keep calm and rational to invest/trade well.
Have an emotional edge + Strong analysis (fundamental + technical)
Having no FOMO might be the most important investing skill. Being immune to the siren song of other people’s success – especially when that success is sudden, extreme, and caused by factors outside their control – is so powerful and important that it’s practically impossible to do well over time without it. When strategizing, Dwight Eisenhower used to quote Napoleon, who said a military genius is “the man who can do the average thing when everyone else around him is losing his mind.” Same with money.
Morgan Housel, FOMO: The Worst Financial Trait
Further, we can make use of the greed and fear sentiment in the market to our advantage.
Buy Fear, Sell Greed.
Portfolio allocation is the last line of defence. We will not know everything. If anything unforttunate happens, it limits the losses.
If you are overwhelmed by greed and unsure of what to do, seek help. Seek help from trusted friends with good investing/trading experience and have a more objective view. Sometimes, when we are having losses, we cannot think clearly as things do not go our way.
Greed, for the lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge [sic.] has marked the upward surge of mankind.
Gordon Gekko from the movie, Wall Street
Related posts:
Managing losses: A very important skill that investors and traders must have
The great investing myth (1): Buy low, sell high
