Warren Buffet calls it calculated, Ivan Boesky (1987 Wall Street Arbitrageur) said it's good, Catholicism considers it one among the top seven sins and environmentalists may call it a disease. Greed means different things to different people. And speculation though considered the foundation stone of the capitalist society, in its extreme form, greed, can bring everything down.
It does not take much, to tip over the other side, the cycle of human folly repeats, says Peter Hamilton, in his book, ‘The stock market barometer’. The greatest essentials in the development of a nation, speculation leads to healthy risk-taking. However, pushed harder, the virtue loses its balance and moves to the other unbalancing extreme. Greed is defined as the selfish desire for or pursuit of money, wealth, power, food, or other possessions, especially when this denies the same object to others. So how does something so virtuous become so vicious?
People are mentioned as universally greedy when they link emotionally with rising prices or potential increase in demand of a commodity. Greed clearly talks about attaching too much importance to money, possessing it as an end in itself rather than anything else. Seeing money-making in everything is an extreme imbalance. Martin Pring, the market trainer explains in his book, ‘Investment psychology explained’. He calls extreme leverage or needs to make money fast, greed, and a recipe for a disaster.
A study published by Bard M barber, University of California questions the idea about the success of day traders. The study is based on the Taiwan market. Day traders are not only highly leveraged market participants but also heavy traders. The market participants account for one-fifth of the total trading volumes of the market under study. Individual investors account for virtually all-day trading volumes (97%). Though the study admits that day trading is not entirely a fool’s game, heavy day traders as a group fail. And barely two of ten-day traders make money, fewer do so consistently. No wonder other strategies apart from extreme leveraging, like pyramiding, overtrading, constantly staying in the market, all are classified as typical greed errors. The few big traders who do make money emphasize the need for care with calculated and small bets.
There is another reason why greed takes over and is so prevalent in the market. Greed equates to gambling, while speculation is more of a calculated bet, far from extreme. Another research paper is written by Alok Kumar, University of Notre Dame questions such gambling practices. And about who gambles in the market? The paper concludes with an observation that socionomic and psychological reasons that influence a lottery purchase also lead to excess investment in lottery-type stocks. And individual investors invest disproportionably more in stocks with higher volatility, higher skewness, and lower prices even though these stocks have lower mean returns. These preferences, the paper concludes are distinct from individual investors' known preferences for certain firm characteristics such as small-cap stocks, value stocks, etc.
In contrast, institutional investors prefer stocks with higher mean returns, lower volatility, lower skewness, and higher prices. Collectively, the evidence in the paper suggests that people’s attitudes towards gambling are reflected in their stock investment choices and stock returns. We have a fundamental desire to gamble, the very reason the link between socio-economic dynamics, and the stock market behavior may be stronger than currently believed. This should not come as a surprise, as the psychological, social, economic, religious, and political identities of an individual supersede his identity as an investor. Gambling hence is greed, an extreme form of speculation, more leveraged than normal. Gambling comes with a fixed loss in a lottery. This makes it a crude kind of Option, which expires worthless most of the time.
But despite this historical statistical record of worthless expirations, the greed cycle continues. Tulip Mania saw the price of a single bulb at $ 76,000 in the 1630s. Isaac Newton himself lost 20,000 pounds of his fortune speculating on the South Sea Company, one of history’s worst financial disasters. What started as exclusive trading rights for the South Sea became a mania when more money was made leveraging on the issue of new shares than from actual commerce. In recent times we have Carlyle Capital Corp., the private equity giant which defaulted on $ 16.6 billion debt, after leveraging 32 times its $ 670 million equity. In greed times, the debt to equity ratio of 2:1 is history.
Martin Pring suggests a balance between greed and fear as a solution in his book. He delves into the balance between subjectivity and objectivity, between greed and fear. How both emotions are at two extremes and destined to a financial loss. And just because it’s an extreme, greed takes little to tip over the fear side, vulnerable to outside influences followed by painful unwinding and dramatic changes in social behavior like wars and crashes.
There is more evidence that markets find a way out of extreme greed, sometimes by sharp crashes, and over a sustained period by changes in social behavior. Masses don’t know balance. This is why there will always be greed.