0

Who Is The Greater Fool?

PUBLISHED Jul 26, 2022, 3:52:26 PM        SHARE

img
imgzen investor blog

Who is the Greater Fool?

To put it in the crudest of terms, a greater fool is someone who is dumber than you. At the poker table, if you can’t figure out who the patsy is, it’s probably you. At an auction, the person who grossly overbids because he’s emotionally attached to the artifact is a greater fool. And in investing, the person who buys the stock that you clearly overpaid for is a greater fool. Here are some categories of greater fools in the investment world.

  • Bag holders – the last buyers just before the market tanks.
  • FOMOs – buyers whose sole motivation is a fear of missing out on a good thing.
  • Day traders – overconfident speculators who believe they can out-trade the professionals.
  • Performance chasers – impatient types who quickly dump their recent losers and buy the recent winners.
  • Dumb Money – investors who have no plan, no strategy, no information, and no self-control.
  • Story traders – investors who buy stocks based on how exciting the story sounds.

Cycle of Market Participants

Are You the Greater Fool?

One of my favorite TV shows is HBO’s The Newsroom. The guy who wrote the show, Aaron Sorkin, is known for fast-paced, snappy dialog. In the final episode of season 1, economics reporter Sloan Sabbith (played by Olivia Munn) tells her boss, anchorman Will McAvoy (played by Jeff Daniels):

“The greater fool is someone with the perfect blend of self-delusion and ego to think that he can succeed where others have failed. This whole country was built by greater fools.”

The greater fool theory is a bedrock principle of investing. It’s the belief that one can make money by speculating on future prices, because there will always be a “greater fool” who will come along and pay more than what you paid, even if you paid too much. It relies on the assumption that someone else will be left holding the bag when the price gets too high and the bubble bursts. Speculation based on a belief in the greater fool theory is a great way to make a lot of money, as long as the greater fool doesn’t turn out to be you.

Greater Fools in the stock market

In the stock market, the greater fool theory comes into play when the price of a stock has gone up so much that it’s no longer being driven by rising intrinsic values, but by expectations that irrational bidders for the stock can always be found, and they will be there – ready to buy – when you are ready to sell.

According to the theory, any price, no matter how high, can be justified by a rational buyer under the belief that another party – an irrational buyer – is willing to pay an even higher price.

Those who subscribe to the greater fool theory will often make questionable investments, not because they believe that the current price is attractive, but rather because they believe that they will be able to sell to someone else at an even higher price.

So, the question we need to address is this: should we ever buy an overpriced stock based on the premise that we can make money because of the greater fool theory? There is ample evidence that greater fools do exist, but can we count on them to show up when we need them? In my view the answer is no, for three reasons.

Reason 1. The first has to do with an important characteristic of greater fools: they are heat-seekers. They are attracted to stocks that are hot. They are not interested in value stocks or steady performers. They want action. So, the first problem we have to deal with is the impatience that greater fools have for any hot stock that stumbles, has a hiccup, or otherwise cools off – even temporarily. At the first sign of trouble, these trend-chasers will disappear and move on to the next hot stock. And when that happens, who is left behind, holding the bag? You are.

Reason 2. The second has to do with a characteristic of the market itself. It’s well understood by experienced investors that returns are mean-reverting, which is just a fancy way to say that what goes up must come down. Stock prices are subject to the laws of gravity, and when the price of a hot stock gets too far above its’ average, it will eventually come back down. Here again we are faced with a problem of timing. There is no way for us to know ahead of time when this mean-reversion will happen. And if you happen to be holding the bag when it does, don’t count on the greater fools to be there for you.

Reason 3. The third reason has to do with time. Playing the greater fool game is time-intensive. To do it successfully requires that you pay attention, because price trends can reverse on a dime. It requires checking the stock price at least daily, if not several times throughout the day. Do you have the time, patience, and discipline to do that? Some people do and might even thrive on that kind of action. But most of us have other, more important things to do with our time. Unless you’re a full-time day trader, I would not recommend playing the greater fool game.

Does this mean that investing has to be dull and boring? Of course not. There are plenty of stocks that are fairly priced, or even underpriced, and are still capable of blasting off like a rocket. The smart approach is to buy them when they are cheap and sell them when they are fairly valued. That’s an entirely different game, and it has the great advantage of not forcing you to depend on the kindness of strangers – the greater fools.

So how can you know which stocks are overpriced and which ones are underpriced? There are many stock screening tools out there, and some of them are free, at least in a dumbed-down version. Morningstar, StockRover, Zacks, and your local broker are good places to look.

I keep my own list, which I update weekly and share with clients and subscribers to my newsletter. If you would like to see the latest list of the 10 most overpriced and 10 most underpriced stocks, send me an email at info@zeninvesor.org and I’ll send it right away, with my compliments.

Originally Posted on zeninvestor.org


Sound investments
don't happen alone

Find your crew, build teams, compete in VS MODE, and identify investment trends in our evergrowing investment ecosystem. You aren't on an island anymore, and our community is here to help you make informed decisions in a complex world.

More Reads
Market Musing 7-26-2202, Fed Watch and Tech Earnings Watch
Image

High Volatility: VIX > 23. SPX overall is bearish. Remember that you “can not fight the Fed.” Well you “can not fight the ECB” either.

Mrmd, bros
Image

Headed for substantial growth

What is “Desired” Inflation?
Image

Don’t get me wrong, inflation is a huge concern for those considering retirement, but what can you actually do about it?

Do Trends Exist?
Image

It's not about cycles and trends, but pattern and randomness

Greenback Softens, but Think Twice about Chasing It
Image

Aside from political economic risks, three other challenges are emerging.

Bank of America Stock Price Today - BAC Making Huge Revenues in a Bear Market
Image

Are you hunting the high-value stocks to make high returns even when the pessimism prevails? Bank of America Stock Price Today is just at the lowest level.

Why it’s Time to Start Buying TESLA Long
Image

Is it possible to sell Tesla, the most shorted stock globally, as a potential long buy? On 21 July 2022, Tesla’s stock surged by 10%, attributed to its strong earnings in its Q2 2022 results. The surge was an unpleasant surprise for short traders, who made an estimated mark-to-market loss of over $1 billion.

Does CEO Drama Affect Stock Price?
Image

Elon Musk Affair News Linked to Sell-Off by Sergey Brin

The Fed’s 8-Second Bull Ride
Image

The Fed is on a bull right now, midway through the 8 seconds. The economy is bucking, trying to let gravity and chaos reign above data and order.

Can one make money as an active stock market investor?
Image

In his book, “The Intelligent Investor”, Benjamin Graham describes an Aggressive Investor as an enterprising security buyer who desires and expects to attain better overall results than his Defensive or Passive companion.

Money Market Vs Stock Market
Image

Some folks have asked Piggy whether to start off by investing on the money market or stock market. The fact about the matter is that these are two asset classes with different characteristics.

Building a Base: A Good Start
Image

Stock Market Commentary

Neither a Crypto Borrower nor a Lender Be
Image

As I have said before, look at the underlying economics of an investment rather than its external form. It doesn’t matter whether it is public or private.

Dismal EMU Flash PMI on Heels of First ECB Rate Hike since 2011
Image

The euro is over a cent lower from yesterday’s peak, pressured by the drop in the flash PMI composite below 50 for the first time since early last year.

Verasity: Revolutionizing AdTech Through Web3
Image

With blockchain technology on the rise, what happens when disruptive technologies meet with adtech? We're going to explore this topic in depth by looking at a company called Verasity.

Is Gold Still Precious?
Image

The outlook for gold in the context of its long-term price trend

Investing Basics: 7 Common Types of Mutual Funds
Image

A quick guide guide to the 7 types of Mutual Funds

Paying Off Debt and Your Credit Score
Image

Some people are surprised to learn that paying off debt does not instantly increase a credit score.

A look at the Manufacturing Sector
Image

One of the foundational principles in the theory of international trade has to do with comparative advantage.

The Price Earnings Ratio
Image

As a follower of the stock market, you most likely might have heard analysts or commentators referring to what are called Price Earnings Ratios (PER). In this article, Piggy would like to demystify PER ratios and also educate folks on how they can make use of this metric to pick stocks on the market.