It’s been awhile since I’ve last posted anything. I took a couple months break while I moved back to Alberta after having spent the last few years in Texas. I can’t say that I’m any more of a cowboy than when I originally left (which was zero). Now that I’m back settled in Alberta, I figured this was the right time to restart the cadence of posts to every four to six weeks as I’ve been trying to sustain over the years.
One of my favorite authors to read from is Morgan Housel. His approach to thinking about money and investing is so simple and common sense that it’s completely fool proof over the long term to ensure financial security for you and your family. I listened to a podcast episode recently where he brings up the topics of fear and greed, and how many people go through this psychological cycle of fear and greed with their investments as the economy goes up and down, as it always inevitably does over time. I wanted to capture the key stages of this fear and greed cycle here in a post while also giving credit to Morgan Housel on developing this framework and covering it in his literature.
So much of investing is psychological. One can go to school and read about all of the theories and mathematics around investing and financial analysis, but actually reacting to the gyrations of the market and knowing when to purchase or sell an investment is much harder to do. Seeing a house that you want suddenly drop in price would, for most people, incentivize a purchase that much sooner to lock in a lower price. However, if you already owned this house and saw its value drop, some may start to worry about a real estate market crash and want to “get out” as soon as possible. If houses actually had stock tickers that were marked to market on a daily basis, I would bet money that some people would behave like this. A place where you parked money for the purposes of long-term appreciation may decrease in value in the short term, spooking the asset owners and causing them to deviate from their original plan of long term value creation. This goes against every principle of responsible long-term investing that you can read in any finance text book, yet we still exhibit this kind of behavior on a regular basis.
Warren Buffet is famous for many quotes, one of which is to “be greedy when others are fearful, and be fearful when others are greedy”. People are most greedy during bullish markets when asset prices have gone up for a sustained period of time, when there is maximum euphoria the markets, and when everyone feels good. On the contrary, people are most fearful when asset prices are collapsing, when there is maximum panic in the markets, and when carnage is being felt across most asset classes leaving no place for investors to hide. Again, investing theory would tell you that one should behave the complete opposite of what I just described, but human psychology and emotions tend to take the driver seat during the extreme ends of market cycle and volatility.
This repetitive human behavior can be summarized in a Fear and Greed cycle, where Housel breaks down this framework into 12 stages. Here is a breakdown of each of the stages, what they are, how humans behave under each one, and what drives them to behave this way.
1. Optimism
Description: This is the early phase of a market rally where investors begin to see signs of growth and improvement in the economy or financial markets. Optimism builds as markets start moving upward.
Driving Emotions/Behavior: Investors are cautiously optimistic but still somewhat restrained. They begin investing more but remain aware of potential risks. Optimism is driven by improved economic indicators or positive earnings reports.
Key Behavior: Gradual increase in investments, but with some degree of skepticism.
2. Excitement
Description: As markets continue to rise, excitement takes over. Investors start to see more concrete gains, and the broader public begins to take notice of the upward trend.
Driving Emotions/Behavior: The excitement comes from seeing financial success and widespread positive sentiment in the media. FOMO (fear of missing out) starts to kick in as people see others benefiting from the rally.
Key Behavior: Increasing investments and more aggressive risk-taking.
3. Euphoria (Max Greed)
Description: This is the peak of the market cycle, where asset prices are at their highest, and most people believe that the market will continue rising indefinitely. Confidence is at an all-time high.
Driving Emotions/Behavior: Greed is the dominant emotion at this stage. People believe they can make large profits quickly. The notion that "this time is different" prevails, and investors believe that the good times will never end.
Key Behavior: Reckless investments, speculative behavior, and high-risk financial decisions. Many investors buy into the market at this peak, expecting even further gains.
4. Anxiety
Description: This stage occurs when the market starts to show signs of instability. Prices may start falling slightly, or there may be some economic uncertainty. Investors are unsure if the bull market is coming to an end.
Driving Emotions/Behavior: Anxiety grows as investors question whether they should hold onto their investments or start selling. They are torn between wanting to protect their gains and the fear of missing out on further profits.
Key Behavior: Hesitation in decision-making; some investors start selling, but many hold on, hoping the market will recover.
5. Denial
Description: In this stage, the market starts to decline more significantly, but investors refuse to believe that the market rally is over. They hold onto their investments, thinking that the downturn is temporary.
Driving Emotions/Behavior: Denial is driven by the belief that markets will bounce back soon. Investors might think, "This is just a correction, not a crash."
Key Behavior: Holding onto investments, ignoring warning signs, and resisting the urge to sell, even as prices fall.
6. Fear
Description: At this stage, the market decline becomes more severe, and the general public realizes that the downturn is not temporary. Prices drop sharply, and panic sets in.
Driving Emotions/Behavior: Fear dominates as investors worry about losing more money. They want to cut their losses but are unsure if they should sell now or wait. The fear of a market collapse overwhelms rational decision-making.
Key Behavior: Panic selling, with many investors exiting the market at a loss.
7. Desperation
Description: This is the stage where investors have already experienced significant losses, and the market continues to fall. Desperation sets in as investors realize they are losing large portions of their wealth.
Driving Emotions/Behavior: Desperation is driven by the fear of losing everything. People who held on through the early phases of the downturn may now sell out of desperation, locking in losses.
Key Behavior: Mass selling, even at low prices, just to avoid further losses.
8. Capitulation (Max Fear)
Description: At this point, the majority of investors give up. They sell their holdings at any price, no longer caring about the market or future recovery.
Driving Emotions/Behavior: Capitulation is driven by complete loss of confidence in the market. Investors become risk-averse and may swear off investing altogether.
Key Behavior: Selling at the bottom of the market, usually marking the end of the downward trend.
9. Despondency
Description: This is the emotional bottom of the cycle. Investors feel hopeless, having lost a significant portion of their wealth. There is little interest in investing, and people avoid the market altogether.
Driving Emotions/Behavior: Despair and regret dominate this phase. People are disillusioned with the market and have little hope for recovery.
Key Behavior: Avoidance of investing, even as the market starts to stabilize.
10. Depression
Description: In this stage, the market is still at low levels, and there’s widespread pessimism about the economy. Investors are still in shock from their losses and are extremely cautious.
Driving Emotions/Behavior: Depression is characterized by extreme risk-aversion. Investors are reluctant to re-enter the market, as they fear further losses.
Key Behavior: Avoiding the market, extreme conservatism in financial decisions.
11. Hope
Description: After the market has bottomed out, early signs of recovery begin to appear. The market may start to rise slightly, but the majority of people are still skeptical.
Driving Emotions/Behavior: Hope starts to return as early adopters and more seasoned investors begin re-entering the market. However, most people remain cautious.
Key Behavior: Small, cautious investments as early signs of recovery appear.
12. Relief
Description: As the market continues to improve, more investors gain confidence, realizing that the worst is over. Prices rise steadily, and people begin to feel more comfortable with investing again.
Driving Emotions/Behavior: Relief replaces fear as people see their portfolios recovering. There is a growing belief that the market is entering a new positive phase.
Key Behavior: Gradual re-entry into the market, though still with some level of caution.
1. Optimism (Cycle Restarts)
The cycle then repeats as the market enters a new phase of optimism, and investors begin to anticipate future growth.
The Fear and Greed cycle highlights how human emotions—ranging from optimism to euphoria, fear to despair—can drive irrational decision-making during market cycles. It explains why people often buy high during the euphoria phase and sell low during the fear or capitulation phases. Understanding these emotions is critical for making rational investment decisions, especially in volatile markets.
Managing the balancing act of your own emotions will make you a better investor, because the market doesn’t care whether you deserve to be right or not with your investments.
As Housel so eloquently states, “All greed starts with an innocent idea: that you are right, deserve to be right, or are owed something for your efforts. It’s a reasonable feeling.”