Get a mental image of your favorite amusement park. Once you´ve made your way through the line, you find your favorite roller coaster towering over you like an ominous beast. Every possible safety precaution is made and off you go, racing toward what feels like certain disaster. Once you complete this frightening journey, the thirst for more sends you back to the line, as you anxiously wait for another rush of adrenaline. For the investor, such is life in the stock market, with greed and fear providing excitement that an amusement park could only hope to match.
Recently, greed and fear have run more rampantly with the bulls and bears on Wall Street. With record losses followed by triple-digit gains, each week is like a roller-coaster, a blur that perfectly shows the effects that greed and fear can have on a portfolio. While such turbulence in the market creates opportunities for profit, the possibility of devastating losses also exists. This instability provides the conditions where greed and fear can have destructive effects on investors´ decisions.
Love and Marriage of Greed and Fear
Frank Sinatra once sang, ¨love and marriage go together like a horse and carriage…you can´t have one without the other¨; this type of symmetry also applies to greed and fear in the stock market. Profit-takers are frequently motivated by greed, and fear of loss can leave investors selling even when they are in negative positions. With all this turmoil, the question becomes ¨how can an investor defend against the dangers of greed and fear¨? While these are both dangerous conditions, there are good answers for each.
Ultimately, the recipe for overcoming greed and fear is a solid trading plan. This plan should be an investor´s guide to how he or she plans to approach the market, thus eliminating emotions like greed and fear from the equation. When emotion is removed from the investor´s approach, following an investment strategy becomes much easier.
Though both need to be eliminated, greed and fear are typically confronted in different ways. Greed is more commonly seen among profit-takers, when the temptation is great to let a winning position ride, wringing every penny of profit out of the run. Such a tendency can be eliminated by such techniques as momentum trading, where an investor locates a stock that is trending upward and stays with it until a peak is identified and selling close to that peak. Such a technique forces the trader to exit the position without riding it to a loss.
Fear can also be eliminated with a successful investment plan. Stop loss strategies can help an investor make, and protect, a profit. As a position becomes profitable, a trader can create a stop loss, or a sell point at which the stock cannot fall below. If that target is a trailing stop, the sell point rises with the stock price, protecting more of the profit. As with the trading strategy above, each of these techniques can be invaluable for protecting against greed and fear.
Riding the Rollar Coaster
These days, investors in the stock market are a daring bunch, braving risk like the thrill-seekers at any amusement park. While these passengers take every precaution with their safety, riders on the Wall Street roller coaster need trading plans to protect them against the thrills of greed and fear.
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