What is the Greater Fool Theory?

by Investing School on December 22, 2010

The “Greater Fool Theory”, which is also sometimes referred to as the “Bigger Fool Theory” or “Survivor Investing”, refers to an idea that states that it is feasible to make a profit through the purchase of securities regardless of whether they are overvalued. This theory operates on the assumption that it will always be possible to sell overvalued securities at a profit, due to the thought that there will always be a “bigger/greater fool” who will be willing to pay an even higher price.

When making investment decisions based on this greater fool theory, investors will purchase questionable securities even if there are serious doubts about their overall quality. They will do this solely in hopes of being able to turn around and sell them another investor – who is probably looking to do the same thing! This perpetual search for a bigger fool needs to reach its end at some point, however, because bubbles of speculation will burst sooner or later. In these cases, it leads to serious devaluation of the share price because of the sell off.

While there are some investors, especially momentum investors, who view the Greater Fool Theory as a valid pathway to achieving profits on the stock market, more fundamental investors are of the opinion that there will come a time when market participants finally come to the conclusion that the price is simply far too high or low. The overall reliance on constant market optimism and momentum with regard to one particular stock or industry type makes this a higher risk endeavor.

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