The Psychology of Market Panic

NPR has an interesting short interview with Tim Harford, columnist for the Financial Times and author of “The Logic of Life: The Rational Economics of an Irrational World”, about why people panic in difficult markets.  Seems this is an affliction men suffer more than women, attributable (once again) to an abundance of testosterone overpowering our better judgment. 

Here’s an article in Psychology Today by David Pincus that focuses on the confidence game inherent in the market. Here’s a snippet:

Albert Bandura has led research into confidence (technical term is “self-efficacy;” for about 30 years now. The central work in this area was based on building confidence in snake phobics, exposing these individuals to Boa Constrictors and assessing which factors most successfully predict their ability to eventually face or handle these snakes. Bandura’s primary result was that confidence beliefs predicted success more strongly than any other factor studied, even past success. So belief is crucial, at the level of the individual, and apparently at the larger scale of this complex network – the collective confidence of people in the markets. In other words, the confidence of individuals is critical, as collectively this confidence emerges at the much larger scale of collective behavior within the economy. Confidence is contagious among individuals, as is chaos and panic. The recent fatal run on withdrawals from Washington Mutual is a clear example. The confidence of the part, the individual, is critical for understanding the confidence of the whole, the collective behavior of the markets and the banks. The reverse is true as well. My inclination to pull out of my 401K, to buy gold and bury it in the back yard will combine with that inclination of others as the market drops in day-to-day 10% chunks, and the value of gold puffs up. And these figures serve to feed the catastrophic collapse and ensuing chaos. Continue reading…

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