Greatest Fool Dilemma

Or, "Everyone's in but me."

Knowing when to buy -- or when not buy -- is one of the fundamental prerequisites for ongoing success in investing and speculating.

Today's stock markets provide good examples to learn from. When to avoid buying at the top is one of these. The skills learned from today's inflated stock markets can be applied to other markets when a buying opportunity is found in any item.

The Greatest Fool Theory

This theory is straightforward truth and is so obvious as to be obscure. It states that the price of an item will go up until the greatest fool has bought in. At that point there is no one remaining to buy any more of the item. The sellers out number in force (that is, {quantity of sellers} + {volume of the item}) any potential buyer pool. The market momentum will shift from a buying trend to a selling trend.

The problem is to recognize when the greatest fool is getting ready to buy. If recognized, the market investor and speculator can deduce that it is either 1.) time to sell, 2.) not a good time to buy, or 3.) it may be time to go short.

There are some indicators to be used to analyze an item or market when looking to avoid being the greatest fool, or last buyer in. One test is to review the item's performance. Has it run up relatively fast? Is there a lot of profit for most current owners? Is the item near a multi-month or all-time high?

If any of these questions are answered 'yes', recognize that if you buy in you will be paying a relatively high price for the privilege of joining a group of owners each of whom has a profit. You will be breaking even or at a loss unless up momentum continues. If up momentum continues, will it continue long enough to provide you with a profit?

One other test should be applied after those mentioned. If the item is going up (or up, up, up), and has had a good move up already, is it being recommended by seemingly every analyst covering that market item? And do they say openly that they own the item themselves?

If the answer to these test questions is 'yes', ask yourself, "If they are recommending this to me and they already own it, who is left to buy after me?" The answer may be that there are some or many others, but how many with how much buying power? To buy under this circumstance is to elect to be -- at least for a short period -- the Greatest Fool.

See also: Force

The investment axiom that is always valid: Caveat Emptor

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