Greed and fear can be hard to balance and recognize, especially if you are trying to inform your decisions based on your fear or greed. For traders, While greed can be useful in small doses, it can also lead to irresponsible, irrational decisions that may cause you to lose money. Like greed, understanding fear as it relates to the stock market is incredibly important.
Why Understanding Fear is Crucial: A Trader’s Perspective
Fear is, essentially, the opposite end of the spectrum ranging from extreme greed to extreme fear. The understanding of these characteristics of the stock market or, to be more specific, stock market investors, can be incredibly useful to current or potential investors. This scale is released each day by CNN and considers the following seven factors: stock price breadth, market momentum, junk bond demand, safe-haven demand, stock price strength, market volatility, and put and call options.
Since greed and fear are opposites, too much of either can be detrimental to an investment portfolio. Too much greed can lead to irresponsible investments, while too much fear prevents people from taking risks needed to see a payout from their investment. Fear in its most extreme form would involve not investing at all, instead just letting your money sit in your bank account. You would never lose money, but you would also never make anything that a stock market investor could make.
But an understanding of fear is crucial to invest successfully. Knowing the best times to buy, along with the best times to hang on to current investments or even sell those investments, is of utmost importance to investors. People with incredibly successful portfolios are likely those who can understand and recognize their greed and fear. Being able to recognize when the emotions of individuals may be deceiving them based on hard numbers is a valuable skill for any stock market investor.
Out of all the actions resulting from an abundance of fear, the most common is abandoning a stock too quickly before it has time to yield a profit. This happens a lot with people who are too inexperienced to know that you need to hold onto a stock for a longer time before it will start paying itself off. It is also essential to understand that investing when fear is slightly higher than usual is the way to go. Stock prices tend to dip as fear gradually increases, and, if you are confident prices will rebound despite the increase in fear by shown by the majority of investors, you can cash out big time. People tend to sell investments as fear increases, driving prices down. All you have to do is recognize that this is what is happening, evaluate whether that fear is warranted, and act accordingly.