In the investment world (as with all worlds involving the act of buying & selling something), there is a term called the Fear & Greed Pendulum.
The acts of fear and greed persist over the ages of time simply because humans are susceptible to volatile emotional changes. In order to understand about the emotions of fear and greed, we need to first understand how emotions came into being.
According to Wikipedia:
The amygdala (plural: amygdalae; /əˈmɪɡdələ/; also corpus amygdaloideum; Latin, from Greek ἀμυγδαλή, amygdalē, ‘almond’, ‘tonsil’[1]) is one of two almond-shaped groups of nuclei located deep and medially within the temporal lobes of the brain in complex vertebrates, including humans.[2] Shown in research to perform a primary role in the processing of memory, decision-making, and emotional reactions, the amygdalae are considered part of the limbic system.[3]
A study has shown that the right portion of the amygdala actually controls negative emotions, and the left side controls positive emotions. It is amazing that such a small part of the brain actually controls drastic behaviors which affects our entire life decisions and actions! (Imagine if someone could discover a technique to “disable” the amygdala at will!
In fact, it is due to this 2 small bulbs of the brain that has been affecting the irregularity of the entire financial industry. Investing has and will always involve human emotions and human psychology, simply because the works of investing will always require humans to perform. Although humans have been actively attempting to remove the equation of emotion by introducing algorithms and quant investing to perform investments on our behalf, however there must be actual humans at the other end of the spectrum in order for the algorithms to work, since these algorithms are also based on the fluctuations of human emotions for them to work.
If you are a big fan of Warren Buffett, you might have heard of his saying:
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”
These are fine words which most people find it extremely hard to act upon, and in fact this is the final deciding factor to determine whether a person belongs to the groups of an “Investor” or simply a “Trader”.
Fear and greed are two most primary emotions which motivate you to take action or inaction.
How does emotions affect the stock market (and every other market?)
Emotions determine market sentiments and short-term prices move from one extreme to other like a pendulum:
In fact, the pendulum effect is so effective that the time it stays in the Neutral zone only lasts a tiny fraction compared to how much time it stays in the Greed & Fear zones (much like the swing of a pendulum).
However, it is also due to these extreme swings that investors can reap ultra-high returns on their investments, simply by understanding the mechanics of human behavior.
By being able to be ever-calm and cool headed and study exact facts and valuations, one is able to achieve ultra-high returns simply by entering when everyone is leaving the market, and leaving when everyone else is hurrying into the stock market.
Investment is actually pretty simple when you think of it!
I would like to recommend a book by the legendary investor Howard Marks titled: The Most Important Thing Illuminated. Have a read at this book to understand and spot certain key concepts as shared in this article!
Check out the other posts from my blog: Floats & Moats Part 1 and Back to Basics of Financial Responsibility
