The myth
This famous piece of investing advice is all about going against what most investors are doing. It suggests that the best time to invest is when others are scared of buying and so prices are low.
Conversely, it implies that the best time to sell is when prices are high because most people are overly confident or greedy.
The reality
When financial markets are down, or when there’s uncertainty that might cause a downtrend, investors tend to be cautious. Fear can prompt people to sell off investments, especially highly volatile ones like stocks.
When there’s a great supply of stocks being sold but low demand from buyers, widespread selling can lead to lower prices. Buying the fear means you’ll take advantage of the drop in prices when others seem to be overreacting to negative news.
You won’t worry too much about the decline since you believe that the affected investments are fundamentally sound, and prices are trading at a discount but will eventually return to their “real” value.
Meanwhile, “selling the greed” involves knowing when investors have become overly enthusiastic, and prices have risen beyond sustainable levels.
Instead of buying into the hype, you’ll lock in your gains and sell before a correction or crash happens. After all, prices won’t keep going up forever even if others seem to think so.
The tricky part of following this advice is getting your timing right. You should be able to tell when fear or greed has taken over the markets.
There are market sentiment indices that aim to track the mood of investors. Some aim to show whether fear or greed is prevailing based on indicators like the demand for riskier assets versus safer ones.
These indices can help you gauge sentiment if you’re trying to time the market. Before using such tools to guide your decisions, ask yourself whether this approach aligns with your investing strategy.
For example, market timing may suit you if you’re following an active strategy and need to react to changes quickly.
If you’re a passive investor and would rather invest regularly regardless of market trend, the short-term fluctuations in sentiment and prices may not matter as much.
Verdict: It depends.
This investing advice may work if you’re able to gauge market sentiment properly and you’ll time your trades right. Just remember that doing so can be challenging even for experienced investors.
Additionally, this approach may be a better fit for active investors who buy and sell assets more frequently than their passive counterparts.
However, this advice can serve as a good reminder to resist the urge to follow the herd or let fear and greed affect your decisions. You might already be late to the party or things may be about to take a turn for the worse.
It’s always wise to assess the fundamentals of an investment instead of allowing yourself to be influenced by what others are feeling or doing.
