What is Greed & Fear cycle (related to stock market however influence all walks of life

*The analysis of Greed & Fear cycle is not only affects stock markets but all walks of life includes real estate and other investment portfolios which one can easily relate and understand, hope reader of this article will find this piece of information very informative thanks Deepak Sundrani*

Greed and fear refer to two opposing emotional states theorized as factors causing the unpredictability and volatility of the stock market, and irrational market behavior inconsistent with the efficient-market hypothesis.

There is an old saying in Wall Street, “Financial markets are driven by two powerful emotions – Greed and Fear”.

Legendary investor, Warren Buffet in his 1986 letter to Berkshire Hathaway shareholders wrote that, “Occasional outbreaks of those two super-contagious diseases, Fear and Greed, will forever occur in the investment community”. Investor behaviour driven primarily by Greed and Fear is responsible for the dizzying highs in bull markets and subsequent crash in bear markets.

How Greed affects asset prices and returns

Jeff Bezos, the CEO of Amazon once asked Warren Buffet, “Your investment thesis is so simple. Why doesn’t everyone just copy you?” Buffet responded to Bezos by saying, “Because no one wants to get rich slow”. What Warren Buffet said to Jeff Bezos is the essence of Greed in investment behaviour. Investors want to make profits quickly and bull markets provide a great opportunity to make profits in a short period of time. When price keeps rising, more and more people invest more and more money in stocks. Stock prices follow the law of demand and supply. With higher demand (more money), prices keep rising further and profits grow. Growing profits fuel more greed and more money get invested raising prices to excessive levels. At very high prices, asset bubbles are created i.e. prices are much more than intrinsic or fundamental value of assets. Like all bubbles, asset bubbles eventually burst and prices crash. Investors who had bought stocks at very high prices face big losses when market corrects.

How Fear affects asset prices and returns

When asset prices get overheated it eventually corrects. Bear markets (falling markets) can be triggered by a number of factors but the most common factor is slowing or sluggish economy. It has generally been seen that a stock price fall faster than it rises. 2 – 3 years of gains in stock price can be wiped out in just 2 – 3 months during bear markets. A number of reasons can be ascribed to severe crashes seen in bear markets e.g. high leverage through derivatives near bull market peaks, margin calls getting triggered etc, but the fundamental reason is Fear. When prices fall sharply, investors fear that it will fall more and sell in panic. As mentioned earlier, stock prices follow the law of demand and supply. In a bear market, supply of stocks is high since most investors want to sell in panic. Panic selling causes stock prices to fall sharply. Ultimately, prices fall to such low levels that stock valuations become attractive (cheap) and the markets eventually bottoms out.

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Thank you very much for reading my article as here intention is to share information and enhance knowledge for each & everyone for the betterment & provide more transparency in real estate sector.

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Warm Regards,

Deepak Sundrani