Greed and fear rule the market. For individual investors, the majority base their investing decisions on these two emotions and as a result, end up losing money more often then make money. You might even be guilty of this as well. But I am here to tell you how you can profit off of irrational exuberance.
That’s right, you can take advantage of other investors emotions and make yourself some easy money. Well, if you too are emotion the money making part won’t be easy for you. But if you can keep your emotions in check, this is a surefire way to make loads of money investing in the stock market.
What Is Irrational Exuberance?
Irrational exuberance is when we as humans stop thinking clearly and allow our emotions to completely control our thoughts and decisions. You might have experienced this when a relationship ended with a loved one.
For days and possibly weeks after the breakup, you probably were acting in ways that aren’t like you. The reason for this is your emotions.
Another example is with the housing market back in the early 2000’s. Everyone was buying as prices kept rising. It eventually got to the point where people were buying quickly because they wanted to get in before the price rose the next day.
Once this started to happen, extreme irrational exuberance entered the market. No one thought housing prices could drop. Buying a house was a guaranteed way of becoming rich beyond your dreams.
But then housing prices started to fall and then they crashed.
This is what happens when emotions enter into our decision making process. It’s all part of behavioral finance. We get greedy and buy without thinking. Then we get scared and sell without thinking.
So how do you make money off of irrational exuberance? There are two ways.
#1. Keep Your Emotions In Check
For some, this is easier said than done. You have to learn to not allow your emotions to cloud your decision making process. Think back to all of the times when you made decisions based on emotion. I bet the majority ended poorly.
To help you keep your emotions in check, here is a quick process to follow.
- Stop and think. Before you make a decision, pause for a minute and ask yourself if you are acting rationally or emotionally.
- Step away. In most cases, you can clearly tell if you are acting rationally or not. But sometimes, emotions present themselves as rational decisions. So you should step away for a few days before coming to a decision.
- Review. After a few days have passed, and you had time to think things through, what conclusion do you come to? Is it the same one?
Many times by stepping back and thinking through issues, we allow ourselves to get control and make smarter decisions that are not based on emotion.
#2. Do The Opposite Of Others
This one is easy to spot. When everyone, and I mean everyone is telling you to invest in something, this is your sign that irrational exuberance has taken hold and you need to do the opposite.
If you own what is hot, this is your cue to sell. If you don’t own, this might be a good time to short whatever it is that is hot.
Look at Bitcoin. When housekeepers and taxi drivers were putting all of their money into the cryptocurrency, you know irrational exuberance has set in. I’m in the investment industry and can’t give you a clear description of Bitcoin, yet housekeepers, painters and taxi drivers understand it well enough to invest in it? I don’t think so.
It’s no wonder that it dropped in value by over 50% in one month.
The same holds true on the other side too. When everyone is scared and selling out of their holdings, this is the perfect time to buy. I remember after the market crash of 2008, I increased my 401k contributions and started to buy stock in my company.
I knew that we were close to rock bottom and things would turn around. And they did. As a result of buying in at the bottom, I made a ton of money.
The caveat here is that you will never be able to time the market perfectly. You might get lucky and sell at the peak or buy at the low, but odds are you won’t. Looking back, I don’t think I bought right at the bottom, but it was close.
The key here is looking longer term. You aren’t looking to double your money overnight. You are looking to make a large amount of money in a short period of time, say 1 to 2 years.
So there is your action plan for how to take advantage of irrational exuberance. Like I said at the start, it is easy to do. All you have to be able to do is keep your emotions in check. If you can do this, there is no reason why you can’t be making money while others are losing their shirts.
Remember, the stock market is not a zero-sum game. There isn’t always a winner and loser in a trade. But in times when there is, wouldn’t it be great to be the winner?