How Your Emotions Affect the Stock Market

Michelle Melton, Communications Specialist
July 5, 2018

The stock market affects how investors feel. Surprisingly, the reverse is true as well — human emotions affect the stock market. On a public scale, national mood and emotions affect the market as a whole. In fact, studies show that the mass emotions of a country have an influence on national market performance, positively impacting performance on sunnier days when people tend to be happier and negatively on days the national sports team is eliminated from a world championship.1

On a private level, personal emotions affect the investment behavior of an individual. This is because our emotions not only govern how we feel, but they influence how we act as well.

Human emotions play a key role in the decision making process. Our gut feelings help us assess if a situation is harmful or beneficial to us and influence our readiness and tendency to act. In fact, different emotions correspond with specific actions.2 Just as fear can trigger one to flee in a survival situation, fear of losses can trigger investors to pull out of the stock market in a downturn.

Understanding the way emotions affect the stock market can help you advise clients to avoid making emotional decisions with financial consequences. As your clients ride the emotional roller coaster of investing in the stock market — the market cycle of emotions — it is important to remind them of the inverse relationship between feelings and investment opportunities at the peak and valley of the market performance cycle.  This general cycle is demonstrated conceptually below.

Cycle of Market Emotions

The Upturn: Optimism, Excitement, Thrill and Euphoria

When investors enter the market, they feel optimistic about investing and confident that their risk will pay off in the long run. As the market goes up, emotions become increasingly positive until they peak with a feeling of euphoria when returns are highest.

The Downturn: Anxiety, Denial, Fear and Desperation

As the market starts to dip and investments lose value, uncertainty will make investors feel nervous. They may anxiously watch the market until denial takes over and they regain confidence in their long-term investment strategy for a short time. When the market doesn’t improve, investors will become increasingly fearful of losses as they are unsure how far the market will fall.

The Bottom: Panic, Capitulation, Despondency and Depression

At the bottom of the cycle, continuing decline and losses lead to panic. Despondency and depression make investors lose hope in the market as they wonder how they could have been so wrong. Ironically, it is when they feel most discouraged about their investments that they potentially have the most to gain — the point of maximum financial opportunity.

Feelings of depression and desperation may make clients rethink their risk tolerance and tempt them to throw in the towel. When this happens, remind them that wise, long-term investors avoid the urge to sell when their portfolio is worth the least but consider buying in a market that has fallen.

The Upturn: Hope, Relief and Optimism

When the market begins to recover, investors will feel hopeful that it will continue to climb. As conditions continue to improve, hope and relief may also be met with skepticism as they wonder if the growth will last. As the market recovers, investors will regain optimism, once again feeling enthusiastic about their investment opportunities.

While everyone experiences the same emotions as they watch market performance, successful investors avoid the innate emotional tendency to buy high and sell low. Remind clients that they are working to reach their long-term financial goals to help them stick to their investment plans when emotions run high.

 

1 Emotion and Decision Making, Annual Review of Psychology, Volume 66, 2015

2 Emotion and action, Philosophical Psychology, Vol. 15, No. 1, 2002

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