Thursday, 8 October, 2009

Theory of the Greater Fool

Theory of the Greater Fool

All of us in the markets are familiar with the theory of the "Greater Fool" - In a raging bull run, the idea is to keep buying stocks with the fond hope and a fervent prayer that there will be a bigger fool who will be eager to buy the same stocks from you at a higher price in the next few days, weeks or months!

The inimitable Nobel Laureate John Maynard Keynes, in his masterpiece "The General Theory of Employment, Interest, and Money," elucidates this point elegantly.

He pointedly referred to the inconvenient fact that "there is no such thing as liquidity of investment for the community as a whole."

Whatever the asset class may be—stocks, bonds, real estate, or commodities - the market will seize up if everybody tries to sell at the same time.

Financiers were accordingly obliged to keep a close eye on the "mass psychology of the market," which could change at any moment.

Keynes wrote, "It is, so to speak, a game of Snap, of Old Maid, of Musical Chairs—a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops."

If you're not nimble-footed enough to grab a chair when the music stops, better ensure that you buy shares recommended by Buffett - "Those that you'll be ready to hold gladly even if the entire market is going to shut down for the next ten years".

Take care, and safe investing!



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