TWO EMOTIONS THAT RULE THE MARKETS
Two polar opposites reign side by side over the world's financial markets: greed and fear. Faster and faster, this ruling duo passes the scepter back and forth, inciting the volatility we witness-and participate in-each day.
To be sure, greed operates up and down the scale from mild optimism to euphoria. Fear ranges from apprehension to outright panic. The degree to which these two emotions exert power propels stock prices upward or downward. These emotions are never spent, never exhausted. As timeless as the markets they rule, they reign supreme, fueled by their own energy.
Want to see them in action? You can watch them command stock prices any time during the trading day. For example, on a volatile morning, check the price of a liquid stock from one hour to the next. Let's say we're watching Peoplesoft (PSFT), the software giant. When the market opens, the stock is priced at 38. By mid-day, the price has risen to 42.
Now, did Peoplesoft's fundamentals (i.e. quarterly earnings, products, or sales volume) change significantly during that time period? Probably not. Greed pushed the price up. Greed and the resulting demand created by buyers who decided to „pay up“ for the stock. When the price falls-and it will at some point-fear will be the culprit. Much of the time, these two emotions rule according to perception, not logic.
What's this got to do with you? Everything!
Are you greedy? Sure! Are you fearful? I'd bet my new duck slippers on it. „Yeah?“ you reply, crossing your arms over your chest and squinting at me through narrowed eyes. „What about you? Are you ever greedy or scared?“ Absolutely. Although experience (and hard knocks) has tempered these two emotions in me, there was a time very early in my trading career when I'd happily gorge my account with high-flying stocks. If (when) they tanked, I'd get scared spitless and sell out as fast as I could, usually at big losses. Was I a horrible person? No. I was human. And so are you.
When you first venture into the stock market, unless you are different from everyone else in the world, greed and fear will be your constant companions. They're part of human nature. Trouble is, in large doses they color your perception of the market and urge you to make choices you wouldn't make in more rational moments. Some of those choices may be harmful to your wealth.
Greed causes us to chase stocks, or in other words to buy into the euphoria of the moment by agreeing to pay higher and higher prices for a rocketing stock. By the time our order is filled, the buying frenzy has nearly dissipated. The stock usually staggers south, taking our money with it.
When everyone around us screams that a stock is going to the moon, greed urges us to „load the truck“! As our good sense dissolves, we max out our accounts with this dream baby that will surely send our kids to college and us on a luxury vacation. Not. The dream shrinks faster than we can yell, „Sell!“ and our wouldbe profits shrivel with our bottom line. Rats. Double rats.
Greed convinces us to hold oversized positions in rocky markets. It spurs us to grab IPOs (initial public offerings) on the first day they trade. It drives us to gobble up market laggards „because they're cheap.“
Greed's ruling partner, fear, on the other hand, motivates us to action even more quickly. The fear of losing money reigns uppermost in our minds. Fear causes us to sell a winning position too quickly, and interestingly enough it also causes us to hang on to a losing position too long. When the market slaps us hard, fear stops us from capitalizing on the next good opportunity, because we're afraid to „get burned“ again.
How do you eliminate these unsavory feelings from your trading and investing decisions? By learning how to replace them with positive ones. Read this book and others on the subject. Learn how to read market actions and reactions. Move slowly, study hard, and apply what you've learned in a disciplined, cool-headed fashion. If you can accomplish that, you'll have the edge over 99 percent of all market players!
SUPPLY AND DEMAND
Fear and greed act as trailblazers for those age-old economic factors of supply and demand. Many market advisors talk about fear/greed and supply/demand as if they are separate entities. They are not. They are intertwined and perpetuate one another into action.
So, now that you understand how greed and fear operate, let's focus on supply and demand. These two factors move world markets-from rocket ships to jelly beans-around the clock!
The concept is simple: We want what we can't have.
Pretend it's your birthday, and you're so-ooo excited. Over the last six months you've been saving your money for the biggest, most expensive present you've ever given to yourself. Heck, you've worked hard. You deserve it. Now, you're on the way to the showroom floor to plunk down your money on the sleekest, fanciest sports car ever to spin off of an assembly line. Your heart starts to race. An afternoon spent on the telephone and researching the Internet affirmed this was the only one in the area. It's the perfect color – a deep, brilliant red-with buttery, camel-colored leather seats. In a previous test drive, it purred down the highway as if it had found its home.
Once you reach the dealership, you park and start walking toward the showroom. What if it's not there? What if someone else feels the same way you do? No, it couldn't be. That glorious hunk of precision has got your name on it. You enter the showroom and the car fills your vision. Sparkling in the lights, feverish in brilliant red, it seems to whisper your name. You move toward the car as nonchalantly as your shaking legs will let you. You reach out and touch its cool, gleaming metal. Yessss!!!!! This baby is yours. It was created for you. Only you. You lift the door handle, then slip into the driver's side. Sinking into the seat, you breathe in the scent of polished leather. The satin-like wooden steering wheel nestles into the palm of your left hand. Your right foot touches the silent gas pedal, a perfect fit. Your fingers wrap around the gearshift knob, ready to take control of the gutsiest hunk of machinery this side of heaven.
„Here again?“ The salesman's voice jolts you out of your reverie. You take a deep breath and find your voice. „What's the best bottom line you can give me on this baby?“ „The bottom line is gone.“ The salesman smirks. „I just sold it.“ „What? No!“ You jerk yo~r body out of the seat and jam your feet onto the cold, hard floor. Your stomach flips upside down. „You couldn't have.“ „Sorry, buddy. This sweet little baby is going home with its new papa.“ „Wait. Hold it.“ You put your hand on the salesman's arm, as he slaps a „Sold“ sticker under the windshield wiper. „I'll pay you more for it. More than the other guy. A LOT MORE.“ The salesman lifts your hand off his arm. His eyes glitter behind his glasses. „No can do. Got me a signed contract. A deal's a deal.“ Frantically, you clutch your checkbook. „When is the next one coming in?“ The salesman sighs and rolls his eyes. „We're not getting anymore in. Rumor is, it's being discontinued.“ „Discontinued?“ Your pulse pounds in your head. „Hey,“ he leers. „This isn't the only car in the showroom. Couldn't I interest you in another model? Why, I've got a sweet“ „No. No, thank you.“ With your heart crushing your chest, you tum and trudge out of the showroom.
A few days later, you're driving through the other side of town. Suddenly, you spot a large automobile dealer and your gaze travels down the line of cars at the front of the lot. You blink in disbelief. Are you seeing things? An entire line of the car you wanted, sitting idle in the sunlight with flags waving on their antennas. You slow and park.
Before you can get out of your car,a salesman approaches. „Wanna take one of these babies home? Just park it in your driveway and watch your neighbors drool.“
You stand and squint at the lot, shading your eyes from the sun. „How many of that particular model do you have? I heard it was discontinued.“ „Discontinued?“ He chuckles. „Not this creampuff. I've got a dozen on the front lot and more out back. That's why I can give you such a terrific deal on one of them.“ You eye him warily. „How much?“
He spews out the same sticker price displayed by the other dealer.
You shrug, waving him off. „You gotta do better than that. I'll check back with you later.“ As you drive away, you think that guy must be nuts if he thinks I'm paying sticker price, when he's got a lot crammed with the same model. I love that car; but I'm not going to get suckered!
Get the picture?
When only a limited amount of a quality item exists at a certain priceremember the Harley-Davidson craze – we are willing to pay retail prices, and sometimes higher, to own it (demand). But if a huge quantity (supply) of that same item floods the market, the owner typically has to lower his price to sell it. Prices in the commodities markets reflect supply and demand in a big way. If severe winter weather causes the orange trees in Florida to freeze, the reduced orange crop caus~s the cost of orange juice to rise in the grocery stores (demand). Likewise, say you're monitoring your target stock, Bossy Banks, Inc., and it soars to a new fifty-two-week high of 50. You quickly buy 200 shares at that price. The next day, Bossy tanks and heads for the low 40s. „That stupid stock,“ you mutter, watching in dismay. „If it ever gets back to 50, I'm going to sell and get out even!“
During the following week, Bossy sinks to 35. After moving sideways in the mid-30s for a few days, Bossy perks up and climbs to 40 (demand-buyers are willing to pay a higher price). Within another two weeks, fueled by more demand, the stock struggles back to 50.
You breathe a sigh of relief, then shoot your „limit sell“ order to the market: Sell 200 Bossy at 50. Bossy falls to 48.75. Huh? There were too many shares (supply) to be absorbed at 50 by too few buyers. Your order is left hanging. You cancel and lower your price to 48.75. Too late. The stock sinks to 48.65. Frantically, you cancel your order again, and throw in a market order (sell at current inside bid). A moment later, your order is filled at 48.50. By the way, this is called „chasing a stock down.“
Here's where fear and greed, the motivating factors, come in. When you originally purchased Bossy Banks at 50 and it immediately sold off, the fear shown by other buyers that they would pay no more than $50 per share drove the price down. That created supply. The continued supply drove the price down even lower, down to the mid-30s. When supply dried up as new buyers came in, the stock moved sideways (indecision). As buyers committed to higher prices (demand created by greed) at each level, the price rose higher. When it reached the previous high of 50, fear of getting burned again caused you to throw in your sell order. Others felt the same way, and together you flooded the market with supply, once again forcing the stock down. Lowered prices, sustained by fear, pushed the stock back down to 48.50. Eventually, greed steps back in and creates demand and the cycle repeats itself.
So, remember, greed and fear act as the immediate trailblazers for demand and supply.
