Greed and Fear

Yesterday I started a discussion concerning stock trading and how I became involved with Wall Street.  I want to reiterate that I do not claim to be an expert on stock trading, nor do I have a degree in finance or business. The things I am sharing are strictly from my personal experience.

The motor that drives Wall Street and stock trading can be summed up in two words; greed and fear.  This might be an over-simplification of a complex process.  But the fact remains that when greed rules the market, the prices of stocks go up.  When fear takes over, the market falls.  I am not sure if I like the words "fear" and "greed" to express most human motives when dealing with investments.  Instead of fear, I might use the word caution. In the place of greed, I might use the word "optimistic" to express that feeling.

However, fear and greed are not my words, but rather how the market experts themselves refer to the emotions that determine the rise and fall of stock prices.  It makes sense when you consider that anything that causes the nation to enter a state of fear also causes a drop in the stock market.  The events of 9/11/2001 struck a chord of fear into the hearts of every American. But also accompanying fear and the other negative emotions that emerged was a dramatic fall of the stock market. 

But it does not take such a dramatic event to cause movement in the market.  A one-quarter percent rise in interest rates can have a negative effect.  The reports that the government issue every month about unemployment and the economy have an effect on the market. In fact, anything that makes people afraid or fear for the future can and will cause a drop in the stock market.

On the other hand, good news can push the prices up.   On a given day if the employment news is good, the markets will be up.  If we read that a national bank has paid back its TARP funds. stock prices will increase.  In other words, the general investing public thinks they can make some money and their greed drives them to buy stock.

How does the market go up or down? It is as simple as this; when more people buy stocks than are selling, the market goes up. but when more people are selling stocks, then the market will be down. It is strictly a supply-and-demand phenomenon.

So how can the average amature investor make a profit when dealing with a system driven by greed and fear?  The first thing is to acknowledge that these two emotions are in control of the market.  The second thing is to not let these emotions CONTROL YOU.  The fact of the matter is that probably 99% of the market is being driven by greed and fear. This includes the institutional investors that are controlling billions of dollars.

But how can you avoid being afraid when it seems all the news is bad?  Or how can you resist wanting to get your money back when the news is good?  It is absolutely essential that you have a proper spiritual perspective.  Recognising that God is in control of your life and your finances is a good place to start.  Being able to accept loss as well as gain without losing your faith in God is absolutely essential.  Many people tend to blame God when things are bad and forget all about Him when things are good.

How will avoiding greed and fear work for you?  Much of the time because everyone else seems to be selling does not mean that you need to sell.  If you have picked good companies, your stock might be completely safe, even though its price may drop for a while.  You do not have an actual loss until you sell, and if you sell at a loss, you cement the loss and cannot realise a profit.  If you follow the herd and buy when everyone is buying, you may be paying too much, or buying into a "bubble", a condition where emotions have driven stocks to higher values that the underlying companies are worth.

Patience is the most important virtue to display when you are trading stocks.  Knowing when to get in and get out is the most important issue, and should not be based on the "emotion of the day".

We will talk further about this and how to pick "safe" stocks and avoid "shaky" stocks in another session.  I am going to be getting ready to travel and have planned a busy weekend and first part of next week.  So I will try to make another posting before Thanksgiving.  But if I don't get back here before then, I wish you a very wonderful Thanksgiving.