What is the greater fool theory??
Many people lose money in trading and investment because of the phenomenon termed called market bubble. It is worth knowing that every market bubble is influenced by the greater fool theory. Before I continue, the main catalyst of this bubble is FOMO, a financial market term that means fear of missing out. This is explained as people rushing into a market because there are speculations all over about price projections and do not want to miss the opportunity. This instance will give you a quick overview of the whole phenomenon. If you found yourself in West Africa, in Ghana precisely during the Covid era you can relate that the prices of face masks and hand sanitizers were extortionate. Despite the prices being unreasonably high, demand on the other hand was high as well. People in turn bought at high prices and sold them at even higher prices until they could not buy anymore, then people who stocked at higher prices lost money. The prices are lower now than ever, and if you bought at a higher price you will not be able to sell them at the originally intended price.
This is exactly how the greater fool theory works, that the price of an object, asset, and security is not determined by its market rational value or its intrinsic value during a bubble but rather by irrational belief and expectations of market participants that, a person will be willing to pay a higher price for an asset even if the asset price is overvalued. This theory causes a market bubble most of the time, drives asset prices to catalyze the market that prices will always go higher. Eventually, it peaks, then prices start depreciating, and the worse happens.
The Greater Fool Theory is related mostly to the crypto and the stock markets and this theory states that there are always fools who will buy assets from an individual at a higher price than what they could have obtained elsewhere, for some immediate gain to them. Such trading often takes place in a stock market or the crypto market when the price of stocks/crypto has become irrational or when there are no buyers on reasonable terms available elsewhere.
The greater fool theory is the idea that there are always other fools to buy assets from you at a higher price than is offered by the market. Thus, when you sell an asset, you will find another fool prepared to buy it from you at a higher price. If no one else is willing to pay as much as the current market value for your asset, then the only way to sell it is to offer it for less than what you paid for it.
The greater fool theory is based on the assumption that investors react to price and not fundamental value. The term “greater fool” is used because the investor must be a greater fool than the one who sold him the asset in the first place, in order for it to make sense to buy it at a higher price.
For instance, if you sell your crypto for profit, then other investors will have to be a greater fool than you in order for your crypto to become worth as much as they were when you originally bought them.
Now how high is too high? There will always be a greater fool until there is no more and by then the greatest fools must have lost their money and sold their asset at a lower price. This usually happens in “pump and dump” schemes if you are familiar with them because one way or the other, the market always runs out of greater fools so it is important to understand market cycles. Understand the market you are investing in and have your exit price in mind so you would not be the greatest fool.
What people need to understand is that something is worth its price because people agree it is worth that price. Smart investors enter the market when the price is undervalued not when it is overvalued. Smart investors get out of the market when the price is overvalued. Do not invest based on speculative projections, always do your own research and not be the greatest fool.
I Am Cryptoras.