Investor behaviour in bear markets

Posted by Liz Rees in Latest insights category on 07 Apr 20

Psychological traits affect all investors and influence our decisions in both rising and falling markets, but some are particularly evident when we are faced with bad news. It is important to recognise and understand them if we are to become better investors. We highlight below three behavioural biases that you may recognise in yourself.  

Recency bias

This is when we place a greater emphasis on the most recent events and assume that the situation today will continue and we cannot see anything changing. So when markets fall the assumption is that they will continue to fall and investors sell to avoid further drops in the market. Today, investors struggle to see any pick-up in economic activity but whilst the coronavirus (Covid-19) crisis is worrying, if history is anything to go by, people and businesses will adapt and life will return to normal.

Herd instinct

The more we see other people doing something the more we think it must be right, and so copy them, rather than doing our own analysis. This behaviour drives both bubbles and crashes. In bull markets fear of missing out can lead investors to buy expensive stocks whilst this year severe falls occurred because everyone rushed to sell at the same time. Sellers offloaded whatever they could, with little regard to fundamentals, and good companies were marked down along with poor ones.

Loss aversion

We are more sensitive to losses than we are to gains. When our investments are going up in value we tend to feel comfortable about adding to them. As a result investors are most confident when the stock markets are rising but become nervous and reluctant to invest at the lows. Indeed, when share prices have fallen, the instinct for many is to cut their losses and switch into cash.

Be aware of your own behaviour

These behavioural traits are believed to be deep-seated aspects of the human decision making process. As such, the key is to recognise that you, like all investors, are subject them. So take time to recognise in yourself some or all other behaviours mentioned.

Awareness of such biases means you can take control of how you react to them and not to let emotions drive your investment decisions.

It can help to remind yourself why you are investing in the first place, what your long term goals are, and how long you plan to invest for. Ask yourself why you chose an investment in the first place and are the reasons still valid?

Whenever you make a decision make sure you play devil’s advocate. It is human nature to decide on a course of action and then look for evidence to confirm that course. It can be useful to build into your decision-making process the consideration of ‘why we should not do this’ or ‘what could go wrong’. This could be a part of any checklist.

We are now in a new tax year, with a fresh set of tax-free ISA or SIPP allowances available, so you may wish to think about taking advantage of them whilst share prices are low.