Warren Buffet once wrote in a letter to Berkshire Hathaway shareholders that “Occasional outbreaks of those two super-contagious diseases, crypto fear and greed index, will forever occur in the investment community.” This letter was written in 1986, and to this date, fear and greed greatly affect financial markets. In fact, there is a saying on Wall Street that says, “Financial markets are driven by two powerful emotions, fear and greed.”
How greed affects asset prices and investor returns
Most investors who are still new to trading want to get a return on their investments as soon as possible. Bull markets present a lovely opportunity for investors to make profits within a short period of time. When asset prices are on a steady rise, investors want to keep investing more money in the said assets. As most investors know, stock prices follow the law of supply and demand. This means that the higher the demand (money) goes, the more the prices rise and profits grow. More profits present more greed. Investors who have the fear of missing out (FOMO) continue to invest more money to excessive levels. At extreme highs, the prices eventually crash. This means that investors who had bought at very high prices face huge losses when the market corrects.
How fear affects asset prices and investor returns
Bear markets (when asset prices are falling) are triggered by a slowing economy, among other factors. Generally, stock prices drop faster than their rice. This means that in 2 to three months, stock prices that have been rising in 2 to 3 years can be wiped out during bear markets. This can be due to several factors such as server crashes in bull markets, margin calls being triggered or fear. When prices start to fall drastically, investors fear that the prices will continue falling and therefore sell in panic. In a bear market, supply is high because most investors want to sell in panic. Panic sells lead to stock prices falling and when they fall to very low levels, the value of the said stocks becomes very attractive and the market eventually bottoms out.
Investor behavior in market correction
Investors only have control over their actions and not on the financial markets. As such, their reaction to the financial markets determines whether they incur losses or make profits from trading. When prices start falling, most investors are tempted to sell, but when the market value of your fund decreases, this doesn’t necessarily mean that you will face actual loss because the market value of the said fund may go up when the market recovers. Whether you make a profit from the fund you have invested entirely depends on your action, will you do nothing and wait for the market to recover, redeem your investment by closing your position, or think that the price will fall even further and wait for a buying opportunity.
The crypto fear and greed index can tell you when the investors are fearful, but it is almost impossible to time a bear market bottom. However, with the crypto fear and greed index, you have a better chance at making viable decisions because even though you do not have the perfect entries, buying a stock when the market is fearful will most likely earn you a significant profit.