Beginner’s Guide to Market Volatility

3 reasons so many people 'buy high and sell low,' from behavioral finance experts — and social media makes it worse

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Key Points
  • Social media acted as a booster for speculative assets, such as "meme stocks" and cryptocurrencies during the bull market.
  • Cognitive biases that lead investors into mistakes emerge during bear markets, and are often amplified by social media, according to behavioral finance experts.

As markets rallied fiercely off the Covid bottom in 2020, much was made of the boosting effect social media was having on retail investors. Traders on Reddit gave rise to the craze in so-called "meme stocks" while accounts flogging everything from cryptocurrency to NFTs of cartoon apes popped up across Twitter, Instagram, and TikTok.

The environment on social media many market-watchers observed, was not only pushing markets higher, but also leading many inexperienced investors into speculative assets whose risks they didn't fully understand.

Now that many high-risk assets have sold off, some of those same corners of social media have gotten conspicuously quiet, notes Brad Klontz, a financial psychologist and professor at Creighton University. "It's almost like the crypto shillers and stock-pickers have all gone into hiding. It feels like the party is over and they've receded back into their basements," he says.

"They're probably doing what people always do," he adds, "which is buy high and sell low" accidentally, even though they set out to do the opposite.

How social media helps many investors make bad money decisions

When markets are headed toward bear territory, investors' natural inclination may be to sell to avoid further losses. Yet if you poll most investors, they'll tell you, correctly, that you build wealth by buying low and selling high.

So why do investors, especially those who have decades to recover from market pitfalls, effectively sell when things are low? It has to do with a set of unconscious biases, some of which are amplified by the social media echo chamber.

Herding bias

"We tend to herd when things get volatile," says Scott Nations, president of investment volatility analytics firm NationsShares and author of "The Anxious Investor." "Investors get more confused and anxious as markets are falling, and they tend to look around and see what other investors are doing."

In other words, if you perceive that everyone else is panicking based on posts in your social feeds, you may well begin to panic too and forget your plan.

Availability bias

One reason you may think everyone else is freaking out has to do with availability bias — the tendency among investors to judge the frequency of events by the most available data. Think about other times the market has gone down precipitously, and you may gravitate toward major bear markets, such as those that coincided with the Great Depression or the Global Financial Crisis.

In reality, market drawdowns happen all the time — but many investors just forget about them after the market goes up again.

How cognitive bias affects your investments

Video by Courtney Stith

In the social media age, this bias can up your feelings of dread about your portfolio.

"Think about how easy it is to see a tweet. Or to check your account balance every five minutes," says Raife Giovinazzo, portfolio manager of the Fuller & Thaler Behavioral Small-Cap Equity Fund, which invests based on the principles of behavioral finance. "It all makes how much losses are happening more available. And that makes the losses loom even larger."

Selection bias

When it comes to what's actually being shared on social media, selection bias plays a large part in the news you're actually seeing. "When people talk about a subset of things that happen to them, they're likely to talk about the most extreme things," says Giovinazzo.

Just as you probably saw TikToks of crypto bros holding piles of cash in their private jets when the market was booming, you're more likely to see news of people losing their shirts when markets go south. "This can lead to a sense that there is more volatility than there really is," says Giovinazzo.

How to overcome your biases

So how do you avoid giving in to your biases and making emotional investing decisions? The easiest solution might be to ignore financial news and stay off of social media.

Ok, but in the real world?

"Step 1 is to recognize that it's natural to be biased. It's natural to absorb the emotions around you," says Giovinazzo. "There's no simple way to stop feeling that way. It's hardware, not software."

After you recognize that you're going to react emotionally to market news, it may be easier to tell yourself to remain rational and distrust your emotional responses. Setting up a few guardrails that you don't deviate from may also help you stay on track.

Why the best time to start investing is now, even if the market is hot

Video by Helen Zhao

Make sure, for example, that you maintain a diversified portfolio that meets your long-term investing needs. "If you had the bulk of your assets in one or two investments, now may be a good time to adopt a more diversified approach," says Klontz.

Maintain a pattern of investing a set amount on a consistent basis, too, regardless of what the market is doing. This approach, known as dollar-cost averaging, effectively ensures that you buy more shares when they're cheap and fewer when they're expensive.

It may not feel intuitive, says Nations. "We have a tendency to stop putting money into markets when they get choppy. And when the market we increase the amount we're investing and gladly pay higher prices," he says.

But, he adds, "we should be continuing to invest during a down leg and buying at lower prices."

The views expressed are generalized and may not be appropriate for all investors. The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.

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