The Psychology Behind Market Movement
Traditional finance assumes that investors make decisions based on logic, fundamentals, and long-term reasoning. Yet in real markets, stocks rise and fall not only because of earnings reports or economic data but because of emotions like fear, greed, panic, and confidence. A headline can trigger a sell-off; a viral post can spark a rally. Speculative bubbles inflate when optimism outruns reality, and crashes happen when panic outweighs patience. Markets are not machines; they are human environments that react to stress and uncertainty. While traditional finance emphasizes rational decision-making, the reality of the markets shows that psychology plays a central role in whether investors buy, sell, or hold. Internal factors such as fear, greed, overconfidence, and loss aversion, combined with external influences like herd behavior, media narratives, and social sentiment, create irrationality. Understanding these psychological drivers not only explains market volatility but also provides investors with a framework for making more disciplined and strategic decisions. The most successful investors are not simply those with the best data, but those who understand how emotion moves capital and think clearly when others do not.
Close observation of people’s behavior in markets reveals the key role emotion plays in decision-making. Fear often causes investors to exit too early, even when a company’s underlying fundamentals, such as revenue, earnings, and long-term growth prospects, have not changed. On the other hand, greed makes people chase returns after prices have already peaked. Loss aversion makes it harder to cut a losing position than to take a winning one. Behavioral economists like Daniel Kahneman and Amos Tversky showed that investors consistently depart from rational models when faced with uncertainty or risk (Investopedia 2023). That is why market psychology refers to the collective emotional state of investors at any given time. When emotions swing, the market swings with them. The term “animal spirits”, used by John Maynard Keynes, describes this emotional force behind financial decisions. He was an English economist in the early 1900s who concluded that investors may tell themselves that they are being rational, but the data show otherwise (Investopedia 2023). Market psychology can push prices higher even when earnings and performance do not justify it, or the opposite, dropping prices far below fair value due to panic selling. Markets do not always fall because companies are weak, and they do not always rise because companies are strong. More often than not, they move because of fear, excitement, or uncertainty (Forbes 2024). In these moments, markets reflect human instincts more than financial reality..
Markets are meant to reflect value. If a company’s performance is strong, stock prices should rise, and if its performance is weak, stock prices should fall. Yet history shows that prices often move without any underlying change in performance. This is because investors are responding to emotion rather than information. During the COVID-19 crash in March 2020, the S&P 500 fell more than 30 percent in just 22 trading days, even though many companies were still producing revenue and some were growing. The VIX, which measures volatility in the market, spiked to 82.69 during the same month, the highest ever recorded closing price (TD 2024). Nothing in the financial data justified that kind of panic; it occurred purely from investors operating in fear. Similarly, during the dot-com bubble, companies with minimal revenue saw stock prices soar. For example, the NASDAQ rose 582% from 751.49 to 5132.52 between January 1995 and March 2000, only to collapse by roughly 75% from March 2000 to October 2002 (CFI Team 2015). Investor losses were estimated at around 5 trillion dollars. Both cases show the same pattern: fear driving the crash, and emotion setting the price. The disconnect between price and value becomes the widest when investors stop analyzing and start reacting.
This emotional influence is why technical analysis exists. Technical indicators help identify when people are buying or selling based on sentiment rather than value. That is how traders spot panic selling, momentum swings, or retail-driven spikes (Investopedia 2023). Tools such as n-Balance Volume, Open Interest, and Accumulation or Distribution reflect the mood of the market. For example, when OBV diverges from the price, it signals that the volume trend contradicts the price trend and that sentiment towards the stocks may be faltering (Molital Oswal 2025). Behavioral signals such as herd movement, confirmation bias, and recency bias compound these distortions. Fear of missing out makes people buy at the top, and fear of losing money makes them sell at the bottom. These are not random mistakes, but predictable psychological traps that repeat over time (Forbes 2024).
The clearest measurement of emotion in the market is the VIX, or Volatility Index. Also called the “fear index”, this index tracks the market’s expectation of volatility over the next 30 days based on S&P options pricing. In the United States, it is widely known as the fear index because high VIX levels reflect uncertainty among investors (TD 2024). A VIX reading below 15 reflects steady conditions, while levels above 30 indicate elevated fear and potential for large market swings. During major market crises, like the 2008 financial crisis, spikes in the VIX aligned with the panic-driven selloffs, even among some of the largest companies in the world (TD 2024). The VIX can also be a forward-looking tool that skilled investors use to anticipate opportunities. A study from Hartford Funds analyzed moments when the VIX rose above 40, a level considered extreme fear in the market. In every case, the spikes were followed by strong positive returns in the S&P 500 through one, three, and five years (Hartford Funds 2024). When emotions were at their highest, prices were at their lowest, and the data showed that staying invested or even buying created long-term upside. Ultimately, fear collapses prices, and discipline turns collapse into entry. That is how investors who understand psychology in the market use it to their advantage.
That mindset is not just a theory; it is a strategy used by some of the most respected names in finance. Simon Hallet, chief investment officer of the global investment firm Harding Loevner, said, “There is a behavioral edge in any market…markets are still driven by humans suffering behavioral biases” (Hallet 2019). In other words, if most investors are unaware of how psychology affects their decisions, then those who are aware have a built-in advantage. Herman Brodie, a behavioral finance specialist who advises the investment management firm T. Rowe Price, explains why this advantage exists. Humans inherently experience losses at more than twice the intensity of gains, a core finding of loss aversion in his behavioral research (Brodie 2025). This is why many people sell too early during downturns or hold too long during rallies. None of this means that emotion can be removed from investing. It means it has to be understood and managed. Fear and greed are not weaknesses; they are signals. A disciplined investor does not ignore those signals, but they do not surrender to them either. That is why Hallett built an investment strategy that assumes people will act irrationally, and the investor’s job is to anticipate the crowd, not follow it (Hallett 2019). Behavioral finance is not a substitute for traditional analysis. It helps reveal the gap between value and perceived value, where the smartest investors find their edge.
Investing is often described as a numbers game, but markets move on more than math. They move on emotion, greed, and loss aversion shape decisions just as much as earnings reports and interest rates. Throughout history, the biggest crashes and rallies have always been triggered by not fundamentals but the emotional reactions of millions of investors reacting at once. That is why the best investors are not just fluent in balance sheets and cash flows but understand the psychological forces that drive capital. They use tools like the VIX to measure sentiment, not just volatility, and they rely on discipline when others react. In the end, the market will always be human-driven, which means psychology will always matter. In a world where emotion moves money, self-awareness is not just an advantage; it is a requirement.
References
Brodie, Herman. “Decoding Behavioral Finance: Interview with Herman Brodie.” T. Rowe
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CFI Team. “Dotcom Bubble.” Corporate Finance Institute, 2015.
https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/dotc
“Forbes Advisor: Market Psychology—Understanding Emotional Drivers of Market Trends.”
Forbes, June 30, 2024.
Hallett, Simon. “Wherever We Can, We’ve Added Something That’s Based Upon Behavioral
Finance.” The Meb Faber Show, December 4, 2019.
Hartford Funds. “When Fear Runs High, Time to Buy?” Hartford Funds, 2024.
Investopedia. “Market Psychology.” Investopedia, 2023.
https://www.investopedia.com/terms/m/marketpsychology.asp.
Motilal Oswal. “The Psychology of Trading: How to Use Technical Indicators.” Motilal Oswal
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TD Bank Group. “Understanding VIX.” TD Direct Investing, 2024.
https://www.td.com/ca/en/investing/direct-investing/articles/understanding-vix.