Why Markets Recover Before Investors Do: Insights From Behavioural Finance

When markets tumble, the news feels relentless – headlines about losses, uncertainty, and fear dominate the conversation. Yet history shows* that recoveries often begin quietly, sometimes well before investors feel ready to step back in. This mismatch between how markets behave and how investors react is at the heart of behavioural finance: a field that looks at how psychology and emotions influence financial decisions, often in ways that differ from purely rational models.

Table of contents

• What behavioural finance tells us
• Why markets turn before investors do
• The psychological hurdles investors face
• What might help investors close the gap
• The takeaway

What behavioural finance tells us

Behavioural finance is the study of how biases, emotions, and mental shortcuts shape investment choices. Instead of assuming people always act logically, it recognises that fear, optimism, regret, overconfidence and other emotions or biases can affect decision-making. During periods of market stress, these psychological tendencies become especially visible, often making investors act out of fear or panic.

Read Also: Behavioral Finance: Meaning, Types, and Its Importance

Why markets turn before investors do

Markets take in a mix of signals—what has already happened, what’s happening now, and what might happen next. That’s why markets may begin to climb even as sentiment is still low. Investors, however, often move more slowly.

One reason is loss aversion: research shows that people feel the pain of losses more strongly than the pleasure of equivalent gains. This means selling after a drop feels urgent, but buying back in feels risky, even as markets recover. Related to this is myopic loss aversion, where checking portfolios too often during volatile times makes the ups and downs seem even more pronounced and fear-inducing, prompting decisions that may miss a potential rebound.

There’s also the issue of overreaction. When bad news hits, investors, through panic selling or reduced demand, may push prices lower than fundamentals justify. But once the selling pressure eases, markets may potentially recover, even while individual investors remain hesitant.

The psychological hurdles investors face

A few well-documented behavioural biases help explain why investors may lag behind markets:

• Disposition effect: Investors may hold on to losing stocks in the hope of “getting back to even,” while selling winners too early. This can leave portfolios unbalanced and make it harder to benefit from broad recoveries.
• Recency bias and availability bias: Recent, vivid memories of losses tend to dominate decision-making, even if long-term history shows that markets have recovered from many downturns*.
• Herding behaviour: Many investors prefer to wait until others are visibly re-entering the market. But by the time flows return, much of the recovery may already be underway.

Read Also: Impact of Behavioural Finance on Market Conditions

What might help investors close the gap

Behavioural finance doesn’t claim to remove uncertainty, but it does offer practical approaches that could make decision-making steadier:

• Commit to a plan. Having a written strategy—such as when to rebalance or how much risk to take—can reduce emotional, spur-of-the-moment choices.
• Invest regularly. Automatic contributions, such as systematic investment plans, can help smooth out timing decisions and reduce the urge to wait for the “perfect” entry point.
• Rebalance with discipline. Periodically adjusting back to target allocations may naturally lead to buying underperforming assets and trimming outperformers, without requiring predictions.
• Keep it simple. Complex, volatile strategies may make emotional reactions more likely. A straightforward, diversified approach could help investors stay the course during turbulence.

The takeaway

Markets don’t announce when the worst is over. They often begin to recover while investors are still processing the fall*. By understanding common behavioural tendencies—like loss aversion, recency bias, and herding—investors may be better equipped to avoid staying on the sidelines too long. While no method guarantees success, a disciplined approach could help narrow the gap between when markets bounce back and when investors feel ready to join them.

*Past performance may or may not be sustained in future.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBe here.

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