Beware of the greater fool’s game
Chief Economist & Fund Manager
Analyst Insights, Monday, 21st of September, 2020
When major indices crash to the tune of 10% in 3 days, it is a warning sign. When stocks like TSLA lose 30% of their value in 3 days, it is also a warning sign. And the warning sign reads with big bright neon lights – Danger Ahead.
In finance and economics, the greater fool theory states that the price of an object is determined not by its intrinsic value, but rather by the local and relative demand of consumers.
In market terms, the greater fool theory states that it is possible to make money by buying stocks, even if they are overvalued because there will always be a greater fool who is willing to pay a higher price.
This game continues until it doesn’t anymore. At some point, people will refuse to purchase such securities even on the dips for a quick trade. Either because sentiment has changed, or because there is no abundance of fools anymore.
Please note that there are companies in this market trading for 30-50 revenue. Yes, these companies might be growing fast, or are benefiting from the current COVID pandemic, however, it is rare (very rare) that such valuations can be sustained.
While Investment professionals and seasoned traders know all too well the rules of this game and act accordingly, the same cannot be said of the average investor.
The bottom line is that the market is currently in a speculation frenzy playing the greater fool’s game, and extreme caution is warranted.
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