Fear and Greed: Two Critical Factors that Drive Economic Markets

The economic market is very much attuned to our primal instincts; more than we care to admit. Even when experts turn to numbers being crunched, company profiles being carefully studied, and technical graphs being understood, nothing could prepare the market for the onslaught of the most primal of human emotions — fear and greed.

Even when we would like to see and study economic markets as an ideal and self-correcting entity — driven by an invisible hand — it is often distorted by fear or greed. What do we mean by this? In theory, the market place is seen to be ruled by an invisible hand.

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As Adam Smith postulates, the market is self-correcting and efficient as individuals would make profits and maximize them, without the intervention of government. The underlying reason for this is the assumption that people will buy and sell rationally. But do people really behave this way? I’m afraid the answer is no.

Far more often than we care to admit, our economic markets are driven by both fear and greed. There have been instances when greed would dictate the economic market as investors pour money out of excessive desire. In the financial market, greed may be seen in the strategy of value investing. This is the practice of buying stocks that trade for less than their “intrinsic” value, in short, value investors seek stocks that are undervalued. They buy lots of them, and then they sell for a higher price. This can skew to a trend that overvalues a company regardless of whether it’s fundamentals will stand.

On the other hand, markets can also be skewed by fear. In anticipation of danger, such as a downward spiral of prices, investors can start selling their stocks in fear of generating more loses. In a herd mentality of non-thought decisions, this fear-driven phenomenon can create an ever downward trajectory for the market.

As you can see, both fear and greed are critical factors that drive economic markets. During a market correction for example, a greed-driven behavior would have caused the overvaluation of a stock. If investors that think they can earn more for a perceived undervalued stock would start selling for high, this would reach its ceiling and the market will correct itself eventually. This could start the downward trend until the price stabilizes. Fear can be seen in the market correction too. Fear can cause some investors to resort to panic, and therefore, start selling even when the normal behavior should have been to buy when it’s low and sell when it’s high. This can reinforce the downward spiral of the market, which in turn would reinforce greater fear.

So you see, both fear and greed are strong factors in how the market works. Given that these two are inherent and are also the primal motivations behind the volatility of the markets, it is important to be an informed investor. It pays to really pay attention to the market, and not just give in to the trends. It also matters that you know why you are investing in the first place. If you are a day trader, then by all means, listen to the ups and downs of the market. But if you're investing in the long run, then it pays to consider being more rational and level-headed and not heed to fear nor greed that easily.

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