Understanding Volatility – Your Emotions Matter! 

Periods of market volatility can bring out strong emotional responses in even the most experienced investors.

While traditional finance theory assumes we all act rationally and consistently make decisions to maximise returns, real life is rarely that simple. In practice, emotions and ingrained thinking patterns often play a meaningful role in how we respond—particularly when markets feel uncertain. Let’s explore a few common cognitive biases many of us may recognise in ourselves. 

1. Loss aversion  

One classic behaviour is how we naturally distinguish between pain and pleasure. Research shows we are twice as motivated to avoid pain as we are to seek pleasure. This means we feel pain from an investment loss significantly more than we get pleasure from a gain. Even though mathematically it would make more sense to see losses and gains as similar measurements, it feels to us like they are not. This asymmetry leads to risk-averse behaviour when facing potential losses, causing us to either sell investments at the wrong time and lock in a loss, or hold investments for too long to avoid an inevitable loss.  

2. Herd behaviour  

Investors often follow the actions of others, particularly in times of uncertainty. This herd mentality can lead to market bubbles and crashes, as we buy or sell based on the behaviour of the crowd rather than an analysis of fundamental factors. For example, during the dot-com bubble of the late 1990s, many investors jumped into tech stocks without due diligence, leading to a dramatic market correction, with the NASDAQ Composite Index falling 78% from its peak by October 2002. 

3. Overconfidence bias  

Overconfidence can lead investors to overestimate their knowledge or ability to predict market movements. This bias often results in excessive trading and failure to diversify adequately, increasing exposure to risk. For instance, traders may believe they can time the market effectively, leading to impulsive decisions based on short-term fluctuations rather than long-term strategies.  

4. Fear and greed  

Emotional responses such as fear and greed dictate the decisions investors make during volatile market conditions. Fear of losing money can prompt rash selloffs, while greed may lead to excessive risk-taking during market upswings. Understanding these emotions is crucial for maintaining a rational investment strategy.  

5. Recency bias  

This bias occurs when investors give greater weight to recent events or trends when making decisions, often ignoring historical context. For example, if a stock has performed well recently, an investor might overestimate its future performance, leading to poor investment decisions during volatile periods 

6. Confirmation bias  

This bias occurs when investors choose to favour information or interpretations that confirm their pre-existing views. For example, investors tend to look for information that favours their investment decision, such as a positive news article or comment, and ignore ambiguous or negative news such as contradictory data. Unfortunately, this type of bias is becoming more common, as the media becomes more polarising. It can be difficult to distinguish between “fake news” and reality, especially when the “fake news” aligns with our political beliefs.  

7. Availability bias  

This bias occurs when investors rely on immediate examples that come to mind rather than evaluating all the information on a particular investment decision. For example, if a particular investment has received significant media attention, investors may overstate its likelihood of success.  

8. Anchoring bias  

Investors can often rely on a single piece of information when making a decision. This “anchor” reference point can disproportionately influence their judgements and decisions even if this anchor is irrelevant or arbitrary. For example, investors can look at the price of a share investment and anchor to that value regardless of evidence that the stock is worth more or less at a given time.

Recognising these biases is the first step toward becoming a more disciplined investor. While it is impossible to eliminate emotion from decision-making entirely – we are human, after all – awareness of how these patterns influence our thinking can help us pause before acting impulsively. Building a clear investment plan, sticking to a long-term strategy, and seeking diverse perspectives are all practical ways to counteract the pull of cognitive bias. In volatile markets especially, the investors who tend to fare best are not necessarily those who predict movements most accurately, but those who understand their own psychological tendencies well enough to keep them in check.

Coastal Advisory Australia (No.1280080) is a Corporate Authorised Representatives of RI Advice Group Pty Ltd ABN 23 001 774 125 AFSL 238429. The information (including taxation) contained within this article does not consider your personal circumstances and is of a general nature only – unless otherwise stated. You should not act on it without first obtaining professional advice specific to your circumstances.