At times like this, investors should be reminded of behavioral tendencies which lead to knee jerk reactions and mistakes.

1. Overreaction/availability bias. In financial terms, overreaction is the tendency to react in the right direction—but excessively so. Example: An investor who pulls all of their money out of the stock market at the first sign of bad news. “It’s like the investing equivalent of a person who gets upset by a small thing and loses their temper completely,” said Hersh Shefrin, a professor of finance at Santa Clara University’s Leavey School of Business and author of Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing. Overreaction is often related to availability bias, which is the habit of overweighting easily available information. It can be something as small as a client seeing a dip in the account balance on their monthly statement. “If the client is prone to overreaction, something small like that can cause them to question their entire investment strategy,” he said. Availability bias makes the situation worse, since the client will likely put too much weight on information that’s new or easily available, rather than taking a step back and looking at the bigger picture. “Both of these biases tend to lead to mispricing in the market,” Shefrin pointed out. “People assume that stocks that have done really well will continue to do so for a long time, and vice versa.”
2. Focusing on short-term performance. Human beings tend to overweight the importance of whatever’s going on right now. Simply put, we’re wired to be short-term thinkers, and overcoming that tendency is a difficult—but not impossible—task. Investors may feel the pain of a loss in the moment more acutely than they’ll appreciate a gain over time. That’s not surprising, as Shefrin said, “When you lose, it hurts today.” Of course, common sense reminds us financial markets tend to reward patience. But it can be hard for investors to truly believe in a reward that’s years in the future. This behavioral bias is compounded by the fact our media consumption now means we’re bombarded with messages about short-term developments in the financial markets. News spreads through the Internet so quickly, it feels like things can turn on a dime.
3. Following the herd. Warren Buffet made his billions by blazing his own trail. And while most investors would like to follow the same path as the Oracle of Omaha, the truth is the average investor is more likely to simply follow other investors. Herd behavior can lead to all sorts of unfortunate consequences, most disastrously when an investor buys when the market is high and then sells in a panic when things start to go the other direction.
4. Confirmation bias. When you have a strongly held belief, it’s easy to see validation everywhere. This habit of noticing information that affirms your beliefs and opinions while also ignoring or denying contradictory information is known as confirmation bias. It’s powerful in part because it’s reassuring: “Once you’re comfortable with an idea, you feel better when you hear information that tells you you’re right,” Shefrin explained. While confirmation bias plays a role in everything from politics to medical diagnosis, it can be especially damaging when it comes to making financial decisions. That’s because people in the grips of confirmation bias truly believe that they’re making an informed decision—and they don’t realize the information they’re basing their choices on has been skewed by their own preconceptions.