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Greed and Fear in the Market

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Today, I'd made $1000+ selling off positions in the market. Sold one loss making stock and took gains from some stocks that went up. As I was at the computer terminal, a colleague made a remark that seemed very fitting of the typical psyche of an investor. He said that 'fear makes an investor hold back from investment or buying stocks and shares while greed makes an investor want to hold out for even more profits'. After I heard that, I knew that this remark should form the basis of what I would write about.

There is this theory that markets are driven actually by human psychology. If one can understand the madness of the human crowd, you will be able to make a lot of money from the stock market. At what point does a lot of investors decide to buy stocks and shares and when do they decide en masse to sell it all away? Sometimes news that are coming into the market plays a part, at times it is important people like the Federal Reserve Chairman Ben S. Bernanke who makes some remarks to rattle or boost the markets. The people who are the investors in the markets all over respond to their remarks, body language and what they are talking about. The greatest fear of any investor is losing their capital, second is not catching the wind of a bull run. So they watch, listen and read anything that can help them understand a little better.

So actually, if you think about it deeply enough, technical analysis of stocks is actually a derivative of pyschology. Why? When you look at things like moving averages, the different levels of resistance, stochastic indicators etc, they are actually psychological states of minds of masses of investors. Once a resistance level is breached, the psychological states of the investors either believes that the sky is the limit or that everything is going down to hell. Actually, I have reservations about technical analysis when I first came into the industry, but when I relate it to the psychological states of investors, I think it makes more sense and it can serve as a useful indicator of when a stock is turning and where the momentum is going. It is very exciting. Not for the faint hearted.

Greed is when the investor is greedy for more profits and not satisfied with whatever gains that the investment had up to the point. A useful tip here is before you even buy the share, decide what is your targetted return that you will sell off and also more importantly, the stop loss price where you will sell off your shares to cut losses and run. Then, when you have hit your targetted price, take profit and run and if you have losses, cut your losses and run. If you have a system in place, in a rising bull market, you will tend towards making a profit.

Remember both greed and fear are psychological states which all investors have experienced at any one time. The best investors are the ones who have a system in place and do their investment in a logical and systematic way. The best story I have heard is during the 1997 Financial Crisis in the Asian region. There was this man who was said to have mortaged his house took his savings and dumped them all into Singapore Airlines (a blue chip share in Singapore) shares when it was about $7+. The price of Singapore Airlines is about $20+ today. That is a compounded interest of about 11.2% per annum, which is pretty high compared with average stocks returns of 7.5% per annum. But the point is, who will be brave enough to buy into the market when everyone else is selling?

If one cannot overcome the greed and fear mentality in the market, then it would be best to leave it to the professionals to invest in unit trust/mutual funds and check how it is doing once in a while. If fear makes you not want to buy into the market, it will mean that your returns are eroded by inflation and it will quickly eat into your retirement funds. Greed will mean that you are in the market for too long and your returns are again eroded, between the two, fear I guess should be worse then.

I leave you with an article that I found very inspiring from Tortoise Trades.

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