For many investors, these six words not only are profound but also describe a very simple and effective approach that could make you money: "Buy the fear, sell the greed."
- Fear and greed are two emotions that amplify swings in a security's price.
- Investors who give in to fear and panic during a sell-off may be willing to sell a security for an undervalued price.
- Investors who give in to greed may hold onto a security even after it has become overvalued.
- Everyone has these emotions, but by monitoring your levels of greed and fear, you can enhance your investment performance.
Buying When Investors Are Fearful
While you have probably heard this phrase before, it has the power to drive an important point home: If you buy stocks when investors are most worried, during situations when shareholders are dumping stock primarily because they are driven by fear—you can position yourself uniquely to pick up those same shares for a substantially undervalued price.
The Fear Will Fade
Just like everything over time, the fear in the market will fade. Companies will regain confidence. In the medium-term (perhaps over the next few months), significantly undervalued shares (which were dumped during a time of capitulation) could start increasing toward more realistic, much less fearful, valuations.
The Rebound and Selling the Greed
This typical rebound leads the second part of the phrase, which holds true on the flip side: Smart investors who have bought the fear might have to find the most opportune moment to sell the greed.
Greed is typically created by shares that have been increasing in price. The stocks that you bought after investors dumped them during a moment of panic will (almost) inevitably attract the hungry eyes of investors who are watching them rebound back to proper valuations, and possibly even beyond.
The Hope for Even Greater Gains
The funny thing about greed is that it is bottomless. If the shares go up 100 percent, the shareholder gets excited and hopeful that he or she might reach a 150 percent gain. If the value of those shares increases to 150 percent of the price where he or she bought them, that same shareholder will then hold out for 200 percent. Typical investors aren't looking for profit-taking opportunities, they are hopeful for even greater gains.
Once an investment has started moving higher, that is the point at which investors who are sitting on a pretty substantial profit start telling their friends. Many other people who hear about the big investment gains can't resist jumping into the game, which helps drive the prices even higher.
The higher the shares increase, the more greed they will attract. But greed will not help you establish a long-term, reliable, and profitable investment plan. Instead, it locks many investors into the promise of making more money, even after the price has risen above appropriate valuations. That puts them at the risk of holding on to those shares for too long, and perhaps even losing value quickly after the price goes back down.
Don't Let Greed Cloud Your Judgment
Investors should know that greed is like oxygen—it's in all of us. It can't be seen, and it affects every second of our lives, but for some reason, no one really pays attention to it. Therefore, greed can cloud judgment, making people hold on to some stocks way beyond practicality. That is why these six deceptively simple words—"Buy the fear, sell the greed"—are powerful tools for investment. This phrase is actionable advice that brings the essence of years of financial experience and knowledge to all investors, and it could help you determine the best moments to buy and sell.
The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.