Investor Psychology During a Sell-Off – A Wealth of Common Sense

A reader asks:

The S&P returned 18% in 2020 after a chaotic year, in 2021 volatility came way down and the S&P returned 28% – what psychological effects does this have on investors considering how much has gone on the past couple of years and US markets continue to outperform? With that in mind, have the recent sell-offs been totally valuation based or do you think there’s a behavioral dynamic at play as well?

There’s a litany of reasons the stock market is selling off right now (see here for my list).

Obviously, this week has been all about Russia going to war with Ukraine.

But there have been times historically when the stock market ignores geopolitical events, the Fed or economic data.

Then there are times when the markets worry mightily about these factors.

What’s the biggest difference? Why does the market care about this stuff sometimes but ignore it at other times?

If I had to narrow it down to one reason it’s probably price.

After huge gains, some investors are invariably going to find reasons to sell and lock in their gains. And after large losses, some investors are invariably going to find reasons to buy, even when the news continues to look grim.

During a bull market, everyone looks like a genius and it feels like the good times will last forever. Things do get better but eventually they get better at a slower rate.

Once higher expectations are built-in and performance has been good, it’s much easier for investors to sell. When things start to fall many investors want to lock in their profits.

Sometimes these corrections turn into bear markets.

During bear markets everyone looks like an idiot and it feels like the bad times will last forever. Things do get worse but eventually they get worse at a slower rate.

This is how markets bottom and turn higher.

Rinse and repeat.

These cycles don’t work on a set schedule but you get the idea.

Just look at the last three year’s worth of gains for the S&P 500:

  • 2019 +31.5%
  • 2020 +18.4%
  • 2021 +28.7%

Now the Nasdaq 100:</…….

Source: https://awealthofcommonsense.com/2022/02/investor-psychology-during-a-sell-off/

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