How Can We Learn From Fear and Greed?
There are three kinds of investors. The first kind of investor associate more with fear. They invest by minimising pain. The second kind associate more with greed. They invest by maximising pleasure. The third kind don’t know which category they belong to, so they try to do both. They minimise pain and maximise pleasure at the same time. This is the worst kind of investor. It is akin to us trying to bulk up and pile on muscles while only eating veggies. It doesn’t work this way, and we’ll only end up in no man’s land. If we want to be lean, we eat lesser. If we want to bulk up, we eat more.
We understand this general idea, but we love to dabble in what is in-between on how clean our diet is.
We know chicken breast meat, broccoli and eggs is the way to go, but we keep trying to find better replacements. Something that has more protein, something that tastes better, preferably something that goes down as smoothly as bubble tea. Before we know it, we’re simply drinking bubble tea. It applies the same for investing too. We think to ourselves — “If we do this and combine that, perhaps we can have the best of both worlds.”
More often than not, we’re caught in the middle.
We tend to treat fear and greed as flip sides of the same coin. However, they’re distinct from each other. It is crucial to know which emotion we tend to work better with. When we are aware of this knowledge, it helps to manage our behaviour better during periods of fear and periods of greed. Most of us tend to feel more strongly towards fear. We’ll find that the pain of loss outweighs the pleasure we get from gain. A 20% drop in our portfolio hurts more than a 30% gain. In that case, it simply means we need to be more conservative with our investments. It also means we will miss out certain gains when the market rises and we have to accept that.
When we reduce the pain to a level that we can manage, it is a reasonable risk we can handle.
On the flipside, some of us tend to feel more strongly towards greed. We’ll find that the pain of missing out double or triple digits gains hurts more than a sea of red. With this knowledge, we need to be more aggressive with our investments. We’ll always be positioned for bull markets, keeping in mind that we’ll suffer the brunt of the next downturn. Whichever category we fall into, as long as we can sleep tight at night and manage our losses well, we’ll be fine.
Each camp has its own benefits and penalties leveraging on our emotional strengths and weaknesses.
However, there are a lot of moments when we try to have it both ways and it destroys us. We shift back and forth between an aggressive and conservative approach. There is a natural tendency to want to do something when the market goes a little too high or a little too low. We want to sell after bad news and that is typically when the market is already down. We want to buy after good news and that is usually when the market is already up. We want to do these, because we’re wired to avoid pain and pursue pleasure. It feels correct to sell when everyone around us is scared, and buy when everyone feels great. It may feel right, but it is irrational. At the expense of our emotions, we end up buying assets at a premium and selling them at a discount. We need to be honest with ourselves and evaluate what kind of investors are we. The sooner we discover that, the more coherent our behaviours can be. I believe Draymond Green and Dennis Rodman can be good shooters, but they’ll never be better than Steph or Michael Jordan, simply because defence is their game. What is your game?