Greater Fool Theory — How Does It Really Work?
This helps you avoid market traps!
The greater fool theory originates from the field of finance and tries to model crowd psychology around overvalued assets. While this might sound abstract and uninteresting, this theory finds applications beyond just conventional finance.
In any active market scenario, the phenomenon that the greater fool theory tries to model manifests itself. Being aware of this phenomenon and its usual signs would help you avoid falling into potential market traps.
In this essay, we start by covering what exactly the greater fool theory is. Following this, we look at a couple of relatable real-world examples of its application. Finally, we look into ways of benefitting from this knowledge and avoid market traps. Let us begin.
What is Greater Fool Theory?
At its core, the greater fool theory describes a simple market phenomenon:
In any arbitrary market, there often exists a “fool” who pays for an overvalued asset just in hopes of selling it to an even “greater fool” for a profit.
In theory, there are only two possibilities here: either the “greater fool” exists or the “greater fool” does not exist. In practice, however, this kind of behaviour often…
