Posted by: Daryl & Wendy Ashby | December 23, 2010

The Greater Fool Theory

The greater fool theory (also called survivor investing) is the belief held by one who makes a questionable investment, with the assumption that they will be able to sell it later to “a greater fool”; in other words, buying something not because you believe that it is worth the price, but rather because you believe that you will be able to sell it to someone else at an even higher price.

It is similar in concept to the Keynesian beauty contest principle of stock investing.

Some consider it a valid method of making money in the stock market, particularly momentum investors; however, fundamental investors believe that market participants eventually realize that the price level is too outrageous (too high or too low) and the speculative bubble pops. The greater fool theory relies on market optimism and market momentum concerning a particular stock, an industry, or the market as a whole.

The opposite of the greater fool theory is value investing, or contrarian investing, which tries to discount, or even actively go against, the prevailing market psychology. Value investors such as warren Buffett believe that it is corporate profits which are the normal returns from stock investments and any higher return is possible only due to the greater fool theory

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