The Neurological Reason Behind Stock Market Panic

For those that experience excessive fear when the market drops, there are ways to combat it that are more effective than clinging to a teddy bear

Peter Lynch said, “The key to making money in stocks is not to get scared out of them.” He should know. Lynch is not only the author of multiple books on investing including One Up On Wall Street, he also was the portfolio manager of the Fidelity Magellan Fund when it was the best performing fund in the world.

Though most portfolio managers and market historians would agree with Mr. Lynch, what is happening now in the stock market is that some investors are literally scared out of the stocks in their portfolios. They sell some or all, even though this behavior goes against authoritative wisdom. Which brings up the question, why would anyone do this?

The answer: they are in a state of fear or panic or near-panic. This fearful condition is motivated by a primitive structure deep in the brain called the amygdala. The amygdala and related connections are clearly more active in some investors than in others when the market drops significantly. This is due, in part, to past conditioning and inherent genetics. As an example of the former, an earlier exposure to a stressful situation or many of them associated with a release of neurotransmitters can imprint the amygdala and make it more excitable relating to a particular stimulus. For some, this might end up being financial. As a result, fear of not having enough money can act as a panic trigger. Then, stocks can be sold hastily without an override by the thinking part of the brain, the cerebral cortex. The unconscious (the fear center or amygdala) rules the conscious (the rational part of the brain or cortex).

One way to begin to calm this reaction is to determine if secure sources of income match fixed expenses for the coming years; in addition an emergency fund of 3-6 months is always recommended. If these resources are in place, a panic situation can be abated because financial safety is assured even though the market goes down further. If these resources are not in place, they need to set in motion as soon as possible without losing major existing market share. This might mean waiting until the current market situation has resolved. Since traditionally bear markets last only eight months to one and one half years, this could be soon. It is optimistic that another bull market, when it arrives, traditionally will last much longer, seven to eight years. Perhaps, as Franklin D. Roosevelt said, we have nothing to fear but fear itself.