Why Market Sell-Offs Feel So Stressful | Investor Psychology Explained

Market sell offs are stressful. Even if you own great businesses and have invested for the long-term, huge drops in market prices are emotional.

Panic sets in. Headlines become sensationalized. Decision making is more difficult than it needs to be.

It’s frustrating because usually nothing has changed. The businesses aren’t crumbling. Customers aren’t suddenly going bankrupt en masse. Revenue isn’t drying up. Nothing.

Yet investors act like something is wrong.

Most of your stress during these times isn’t caused by the market. It’s caused by very predictable mental pitfalls you fall into when prices swing violently.

If the current environment is starting to feel overly stressful, psychologically speaking, there’s almost always one or more of the following four reasons why:

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Reason #1: You Don’t Really Know the Businesses You Own

Panic selling occurs when investors own businesses they don’t truly understand.

When prices decline, every dip feels personal. Every nick in the stock price feels like new negative information being revealed.

If you don’t understand the business you own, pay less attention to short-term price movements and investor emotion. Learn about the business.

Read about how the business makes money. Study the financial statements. Assess whether the competitive advantages are getting stronger or weaker.

Once you know a business is profitable, growing, and resilient, short-term price movements don’t register emotionally. The quote gets white noise treatment. You learn to ignore it (or buy).

Sell businesses that you don’t understand or like. Capital should be allocated toward businesses that you know well and have conviction in.

Reason #2: You Mistake Market Price for Business Value

Another big psychological pitfall is that investors often mistake price with value.

Remember markets trade like auctions in the short-term. They constantly overshoot to the upside and downside. When volatility spikes, mispricing occurs and prices can detach from business value.

Investors make the mistake of judging their investment performance by price movement. If prices rise, they feel good and think the business must be doing well. If prices fall, they assume something bad must have happened.

Yet for most businesses you own, very little changes from one quarter to the next, or even over the course of a year. Revenue grows. Customers pay their bills. More cash is generated. Many businesses are actually better today than they were 12 months ago, yet the price is lower.

If price moves lower because of panic selling or broader shifts in investor sentiment, don’t view it as automatic failure. If the business continues to improve, falling prices are merely disconnected from underlying performance trends. When you can mentally detach price movements from business performance, you’ll feel less emotional stress.

Reason #3: You’re Using Short-Term Money or Borrowed Money to Invest

Notice the words used during periods of intense selling. They typically include words like “bleeding,” “blood bath,” “falling knife,” etc.

Fear sells. When investors are fearful, negative words invoke emotion which fuels more fear. Emotion drives behavior, and if you let it control you, it can cause serious investment mistakes.

Remember, if you aren’t forced to sell, you haven’t lost anything yet. The market price is meaningless if you don’t need to sell.

Think about a simple example: You own an apartment in a great location. It’s well maintained and rents for $2,000/mo. Someone next door gets divorced and needs to sell their identical apartment quickly. On the open market, they can only get $150,000 because of their situation. Did you just lose money on your apartment? No. Just because someone else sold at a low price doesn’t mean you have to sell at a low price.

Stock markets work exactly the same way. The only time prices impact you are if you have borrowed money to invest or you need that money in the short-term. Most people who panic sell during periods of panic actually have one of these two factors occur. When prices fall, they get margin called or need the money for an emergency.

If you invested long-term capital that you don’t need for a few years, short-term market movements don’t affect you. “Losses” during a market sell off are often an illusion your mind creates by focusing too much on price.

Reason #4: Poor Portfolio Construction

Portfolio concentration and diversification plays a huge role on how you feel about a market pullback.

If most of your net worth is wrapped up in one stock that’s currently being slammed by the market, then drawdowns will hurt. But that isn’t the market’s fault. That’s on you for not properly diversifying your portfolio.

When you own a portfolio of multiple great businesses spread out over different sectors, you feel less stress. Temporary weakness in one business can be offset by stability or relative strength in others.

Diversification won’t reduce volatility, but it helps you manage volatility.

Market Sell-Offs and Investor Psychology

If you own great businesses, paid a reasonable price for them, and used long-term capital, short-term drawdowns shouldn’t scare you. Ever.

Most of the battle with market sell offs is mental. They challenge your emotions far more than they test your smarts.

Successful investors over long periods of time are not the ones who predict the market correctly. They’re the ones that stay focused on the business, avoid scared money, and keep their emotions in check when volatility spikes.

Know what you own. Understand the difference between price and value. Don’t invest with scared money. Build a robust portfolio of great businesses. Do these things consistently, and market sell offs will become much less stressful (and way more useful).

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Questions About Market Sell-Offs

Got a question about market sell offs? Drop it below and I’ll try to answer it.

Should I sell my stocks if the market crashes?

No investments should be sold solely because the market is crashing. Only sell holdings if the businesses have permanently deteriorated or you need the money.

Why do stock market crashes make me so anxious?

Stock market crashes trigger primal fears that we lose money. When prices drop quickly, that fear is often fueled by media and short-term price movement which heightens emotions and stress.

How do investors stay calm during market volatility?

Investors stay calm during volatility by owning businesses they understand, using long-term capital, and diversifying their portfolio. Also, by ignoring the noise.

How do you deal with market volatility?

Same way I mention above. But another great way is to focus on personal milestones. Stay grounded by measuring your progress towards financial goals rather than market quotes.