How to Stay Rational When Markets Are Irrational

You know that feeling of your stomach dropping when your investments drop? When your investments rise, do you feel the same excitement? You're certainly not the only one. Those powerful feelings can ruin even the best of investment plans.

Let's examine why your mind reacts the way it does and, more importantly: how you can maintain your composure when the market gets crazy. - Learn more about Affirm Wealth Advisors

Why your brain sabotage your investments

Your relationship to money is not only about numbers. It is deeply personal. It is shaped and formed by your whole life.

What are the hidden forces that drive your financial decisions?

Do you think that your financial decisions are rational? Think again. Most financial choices happen in your subconscious:

• Losses feel worse to your brain than gains (winning $1,000 feels better than losing $1,000).
• The evolution of wiring creates a real sense of danger in market crashes
• Fear and greed influence more investment decisions compared to logical analysis

Your financial future is shaped by the past.

Remember how you and your family discussed money in childhood? Those early experiences created financial imprints that still influence how you react to market movements today:

• Early money experiences are linked to neural pathways that can last for decades
• Market crashes have left us with a persistent bias
• Your financial history has a greater impact on your risk appetite than any class in finance

Why Knowing better doesn't necessarily mean doing better

Here's the frustrating truth: knowing what to do with your money doesn't guarantee you'll actually do it. This is why even the most seasoned financial advisors make irrational decisions when they are feeling emotional.

• Market panic can override logical thinking in seconds
• Investments suffer more from implementation problems than from knowledge gaps
• Information alone rarely changes deep-seated financial behaviors

Behavioral Finance - The Science Behind Market Madness

The traditional economics viewed us as rational investors. Behavioral finance shows how emotions drive market moves.

From Rational Theory To Emotional Reality

The field was born when researchers began noticing patterns of irrational and unsustainable financial behavior.

• Classical economics couldn't explain why markets consistently overreact
• The 1970s saw the revolution in understanding brought about by psychologists Kahneman & Tversky
• The 2008 financial crash pushed behavioral financing into the mainstream

Why Markets Aren't Always Rational

Despite what the textbooks say, markets aren't perfectly efficient. Human psychology creates persistent inefficiencies:

• Assets can be mispriced by emotional reactions
• Investor herding causes boom-bust cycles that go beyond fundamental values
• Bubbles and market crashes are caused by psychological factors

Investment Principles that Every Investor Must Know

When emotions cloud your judgement, you can recognize them by understanding these concepts.

• Loss aversion is a phenomenon where losses hurt about twice as bad as similar gains.
• Recency bias: Too much emphasis on recent events
• The anchoring effect is when decisions are tied to arbitrarily chosen reference points, rather than fundamentals.

The Emotional Investment Traps That We All Fall For

The built-in shortcuts in your brain helped our ancestors live longer, but they could ruin the returns on your investments. Let's identify these biases so you can overcome them.

Fear-Based mistakes that cost money

Fear of losing money is more common than other emotions.

• Loss aversion makes you sell winners too early and hold losers too long
• The time of greatest opportunity is precisely the time that risk aversion increases.
• Inflation slowly erodes cash positions when you catastrophize.

When Greed Drives the Wheel

Optimism bias leads you to excessively risk in bull markets.

• Overconfidence causes you to underestimate risks and overestimate your abilities
• FOMO (fear to miss out) makes you pursue hot sectors.
• Selective memory helps you forget past mistakes during market euphoria

Cognitive Blind Spots That Every Investor Has

Your brain is constantly looking for information that will confirm your beliefs.

• Confirmation Bias leads you to ignore warnings signs in investments that are dear to you
• Mental accounting can lead to inconsistencies between accounts when it comes to risk assessment
• Sunk Cost Fallacy: You are stuck with losing strategies because of "you have already invested so many dollars"

Four Market Cycles with their Emotional Rollercoaster

Markets move in psychological cycles as predictable as their price patterns. Recognizing which emotional stage the market is in gives you tremendous advantage.

Bull Market Psychology: The Dangerous Path to Euphoria

Bull markets move in a predictable, emotional order:

• Early optimism provides solid opportunities at fair valuations
• Middle Appreciation builds confidence, but can also increase complacency
• The euphoria of the moment is a warning sign that rationality has been abandoned.

Bear Market Psychology: From denial to opportunity

Bear markets cause emotional reactions that are predictable.

• Denial keeps investors fully invested as markets begin declining
• Fear triggers widespread selling as losses accelerate
• Even in the face of extreme pessimism there are opportunities to be had by capitulating.

Psychologically detecting market turning points

Markets transitions begin with investor psychology before prices.

• Excessive optimism often signals market tops before prices actually peak
• Market bottoms are usually preceded by widespread capitulation
• Sentiment indicators often lead price movements by weeks or months

Practical Ways to Manage your Emotions during Market Chaos

You can learn to control your emotions when markets swing. Stay rational by using these techniques when the markets are turbulent.

Mindfulness can improve investment decisions

Developing awareness of your emotional reactions creates space for more rational decisions:

• Regular meditation improves emotional regulation during market stress
• Body scanning identifies anxiety in your decisions
• Labeling emotions ("I'm feeling scared right now") reduces the intensity of reactions

Why Investment Journaling Will Transform Results

This simple exercise dramatically improves your decision-making quality.

• Your investment journal is a record of your thoughts and ideas.
• Tracking emotions alongside decisions reveals harmful patterns
• Regular reflection increases your awareness of personal financial triggers

Psychological Distance - The Power of Distance

By viewing the market volatility with a detached view, emotional reactivity is reduced:

• Imagine giving advice to someone else instead of yourself
• Use third-person sentences when making decisions ("What do you think Jane should do?"
• Visualize your future self to prioritize long-term outcomes over short-term emotions

Building an investment strategy to work with your Psychology

The best investment strategies take into consideration your psychological tendencies. Aligning your approach with your emotional realities improves long-term results.

Rules-Based Investing: Your Emotional Circuit Breaker

Clear investment rules set in advance will help to avoid emotional decisions.

• Pre-commitment strategies prevent impulsive decisions during volatility
• Rebalancing rules force contrarian behavior when emotions resist
• Systematic investment plans eliminate timing decisions entirely

Finding Your Sleep at Night Factor

Even during market turmoil, you can still stay invested with the correct position sizing.

• Positions that are small enough to avoid panic sales during downturns
• Diversification can reduce emotional attachments to individual investments
• Risk management rules prevent catastrophic losses that trigger abandonment

Matching Emotional Capacity to Time Horizons

Different time horizons require different psychological approaches:

• A longer time horizon reduces emotional reactivity towards short-term volatility
• Stability is improved by using different strategies to achieve various goals
• Mental preparation for expected volatility reduces surprise reactions

Social Psychology of Market Psychology

Markets are social institutions where collective psychology drives price movements. Understanding these dynamics can help you resist unhealthy social influences.

Why We Can't Stop Following the Herd

Humans evolved to be a group-following species for safety.

• Social proof leads investors to popular investments near top of market
• Herding explains why markets overshoot in both directions
• If herding behaviors reach extremes, they can present opportunities for contrarian action

Media narratives and market movements

Financial media amplifys emotional extremes with compelling stories

• News coverage is a reflection of market movement, rather than a leader.
• Media narratives can simplify complex dynamics into dramatic stories
• Headlines are more emotional during periods of market stress

Think Independently Even When Everyone Agrees

Independent thinking has many benefits:

• Cultivate a diverse information diet to reduce narrative capture
• Search for disconfirming evidence in order to support investment theories
• When markets are at extremes, it is best to think contrarian.

How to have a healthier relationship with money

The relationship you have with money can influence the way you invest. Clarifying your money philosophy improves decision quality during market swings.

Redefining Wealth On Your Terms

Wealth means different things to different people:

• Financial freedom provides more satisfaction than pure accumulation
• Understanding your "enoughness" can reduce harmful comparisons
• Absolute wealth may not be as important as control over your time

Aligning Your Money With Your Values

Investment decisions reflect your deeper values:

• Value-aligned Investments Reduce Cognitive Dissonance During Volatility
• Personal commitment provides stability in turbulent markets
• In order to achieve long-term goals, ethical considerations are important.

Find Your Balance Today and Tomorrow

Money can be used for both immediate needs and long-term goals.

• The over-saving of money could lead to unnecessary present sacrifice
• Insufficient savings can lead to future anxiety, reducing today's enjoyment
• Your personal balance point depends on individual circumstances and values

Create Your Emotional management system with Your action plan

When theory is implemented, it becomes more valuable. Let's create a personalized approach to emotional management.

Create Your Investor Policy Statement

Written investment policies provide a reference point that is stable during times of market turmoil.

• Document your investment strategy before the market becomes stressed
• Include specific guidelines for actions during market extremes
• Review annually but modify rarely to maintain consistency

Create your own Circuit Breakers

Predetermined pause points prevent reactive decisions during high-emotion periods:

• Prior to making major portfolio changes, there are waiting periods that must be observed.
• Asset allocation limits that limit maximum adjustments
• Trusted advisors who provide perspective during emotional periods

Every market cycle can be a great learning opportunity

Systematic review turns market experiences into valuable learning:

• After-action review identifies emotional patterns
• Instead of focusing on outcomes, focus more on the process.
• Small improvements compound over an investing lifetime

The Bottom line: Your psychology will determine your edge

Your greatest advantage in investing is your ability to control your emotions when the market fluctuates. Even though you can't influence the markets, the way you react to them can be the most important skill.

What emotional investing traps have you fallen into? How have your learned to manage emotional investing traps? Comment on your experience!