Greed and fear

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Greed and fear - two intrinsic emotional states relating to the topic of unpredictability of stock market. Vulnerability to those two emotional states might be a result of investors’ low comfort level due to the market instability. Greed and fear relate to an old Wall Street saying: “ financial markets are driven by two powerful emotions – greed and fear”. While sticking to this statement would be an oversimplification, it can also prove to be very truthful. Resisting these emotions can have an utter and deleterious effect on investors portfolios and stock market. [1]


Greed[edit]

Greed is usually described as an irresistible crave to posses more of something (money, material goods) than one actually needs.

According to several academics greed, like love, has the power to send a chemical rush through out brains that forces us to put aside our common sense and self control and thus provoke changes in our brain and body. However ,there is no generally accepted research on biochemistry of greed. [2]

Other academics tend to compare greed to an addiction, because greed like smoking and drinking can illustrate that if a person can take over one’s addictions it is possible to avert bad effects from resisting it. On the other hand, if one can not resist its’ temptations, he can easily get swept away by it. In other words it can be deduced that certain traders who join the business world for the emotional agitation and desire of hitting that emotional high, are addicted to the release of certain brain chemicals that determine those states of happiness, euphoria and relaxation. Before-mentioned fact can also imply that such traders are susceptible to all addictions. Furthermore, humans’ brains are naturally activated by financial awards, which in the same way as drugs produce an incredible but perilous feeling and thus an addictive experience. [3]

Dot-com bubble[edit]

One of the most common examples of situations where greed took over people’s action is the 1990’s dot-com bubble. [4]

Dot-com bubble, also knowns as Internet bubble, regarded the speculative investment bubble that was created around new internet starting companies between years 1995-2000. In that time, exorbitant prices of new Internet companies motivated investors to invest into companies which business plan included “dot.com” domain. Purchasing an activities in internet-relesead stocks, resulted in many new companies ranging to a feverish pitch. Investors becomes greedy, determining further greed, resulting in securities being heavily overpriced, which eventually resulted in a bubble. [5]

Fear[edit]

Emotion of fear is usually characterised as an inconvenient, stressful state, triggered by impending peril and awareness of hazard. [6]

Internet bubble is not only a good example of investors’ greed but also the period following the bubble can serve as a good characteristic for fear induced market.

In pursuance of solutions to suppress their losses, fearful investors decided to swiftly move out of the stock markets concentrating their attention on less uncertain purchases, spurring their capital into market securities, stable value funds and principal protected funds, all of low risk and return securities. Such behaviour is an example of a complete negligence of long term investing plan which is based on fundamentals. Investors, disregarded their plans, because of fear of committing persisting losses, which identically did not bring any profits and benefits. [7]

Greed and hope[edit]

Some academics disagree with the notion that greed and fear are main emotions driving financial markets.

According to psychologist Lola Lopes, while fear is indeed a crucial factor driving financial markets, majority of investors don’t respond that much to greed but to hope. Lopes indicates that fear unlike hope, provokes investors to concentrate on unprofitable invests, while hope does complete opposite. Furthermore, hope and fear are believed to alter the manner in which investors estimate other possibilities. Fear provokes investors to ask: How bad can it get?, while hope: How good can it get?. In this case, fear drives investors to enhance security, while hope stimulates investors to emphasise potential. [8]

How to measure greed and fear[edit]

One of the best available and accepted tools to measure stock market volatility is CBOE Volatiliy Index, elaborated by Chicago Board Options Exchange in 1993. [9] In other words, VIX can be defined as a sentiment ratio of Wall Street’s fear or greed gauge. It is usually used by traders to check the grade of investor complacency or market fear. [10]

In practice, VIX is usually called the fear index. In case of increased VIX index, investors' sentiment leans toward higher volatility which corresponds to higher risk. [11] If a VIX reading is under 20 it usually indicates that investors became less concerned [12]. ,however if the reading exceeds 30 it implies that investors are more fearful 
because prices of the options increased and investors are more prone pay more to preserve their assets. [13]

How VIX works[edit]

By utilising short-term near-the-money puts and calls options, VIX gauges suggested volatility of S&P stock market index options through forthcoming 30 days. Media usually quote VIX index , because S&P 500 by many investors it is believed to be a reliable proxy for the entire market. [14]

CNN VIX Index[edit]

There is also another available index that can gauge greed and fear developed by CNNMoney. This index is based on seven indicators: Safe Haven Demand, Stock Price Momentum, Stock Price Strength, Stock Price Breadth, Put and Call Options, Junk Bond Demand, Market Volatility, Safe Haven Demand. [15]

All aforementioned indicators are separately gauged using scale from 0 to 100. A reading from 0 to 50 indicates fear. A reading of 50 is neutral, but the remaining higher readings demonstrate that investors are greedy. To calculate this index a computer takes an equal weighted average of those seven indicators. [16]

See also[edit]

References[edit]

  1. ^ [1], Investopedia, (2010). The Financial Markets: When Fear And Greed Take Over. [online], [Accessed 31 Oct. 2014].
  2. ^ Toghraie, A. (2011). Trading on target. Hoboken, N.J.: Wiley.
  3. ^ Furnham, A. (2014.). The new psychology of money.
  4. ^ [2], Investopedia, (2010). The Financial Markets: When Fear And Greed Take Over. [online], [Accessed 31 Oct. 2014].
  5. ^ [3], Techopedia.com, (2014). What is the Dot-Com Boom? - Definition from Techopedia. [online], [Accessed 31 Oct. 2014].
  6. ^ [4], Dictionary.com, (2014). the definition of fear. [online], [Accessed 31 Oct. 2014].
  7. ^ [5], Investopedia, (2010). The Financial Markets: When Fear And Greed Take Over. [online], [Accessed 31 Oct. 2014].
  8. ^ Shefrin, H. (2000). Beyond greed and fear. Boston, Mass.: Harvard Business School Press.
  9. ^ [6], Wealthdaily.com, (2014). VIX Index. [online], [Accessed 22 Oct. 2014].
  10. ^ Thompson, S. (2009). Trading secrets. Harlow, England: Financial Times/Prentice Hall.
  11. ^ [7], Little, K. (2014). Fear Index Can Warn Stock Investors. [online] About. [Accessed 22 Oct. 2014].
  12. ^ [8], Wealthdaily.com, (2014). VIX Index. [online], [Accessed 22 Oct. 2014].
  13. ^ [9], The Economist, (2014). Market volatility. [online], [Accessed 22 Oct. 2014].
  14. ^ [10], Little, K. (2014). Fear Index Can Warn Stock Investors. [online] About. [Accessed 22 Oct. 2014].
  15. ^ [11], CNNMoney, (2014). Fear & Greed Index - Investor Sentiment - CNNMoney. [online], [Accessed 31 Oct. 2014].
  16. ^ [12], Investopedia, (2013). Fear And Greed Index Definition | Investopedia. [online], [Accessed 31 Oct. 2014].