If you’ve had experience investing in any asset class, the you’ll know that there are certain market conditions that can impact the way that investors behave. Let’s face it, a lot of personal finance management has to with investor psychology and reacting to specific market trends. So when it comes to bull and bear markets, you can most definitely expect to see some common trends in behavior by a majority of investors who are simply reacting to how the entire market is performing. With that being said, let’s go into what bull and bear markets are and how they affect investor psychology in the short and long term.

This is not financial investment advice.

This article will touch upon key aspects of investor psychology related to bull and bear markets.

The Bulls

Bull markets are what most investors want to see, especially since that means their original investments will be growing fast. Broadly speaking, bull markets are financial markets in which prices are rising or are expected to rise for a sustained period of time. They are characterized by optimism, investor confidence, and expectations that strong results should continue — usually for months or years.

When a bull market emerges following a period of little to no significant growth, investors feel inclined to participate and get involved with hopes of large returns. Specifically, we see strong demand and weak supply for the assets involved. In other words, many investors seek to buy securities while few are willing to sell. Resultantly, prices will rise as investors compete to obtain available equity in the market.

Since market sentiment is generally positive during this time, people will want to invest and participate when price values are increasing. However, this can cause bad investing habits since the goal is to invest when prices are low and sell when they’re high. If you make the mistake of falling into the FOMO — fear of missing out — and try to purchase assets when they’re already trading at high prices, you’re more likely to lose money if prices fall after.

Bull markets are characterized by sustained periods of positive price movements for the assets within a financial market. Investors have a positive market sentiment and are much more likely to introduce cash positions.

The Bears

On the other hand, there are the bear markets which also cause investors to act in a specific manner. Bear markets are characterized by share prices which are continuously dropping, resulting in a downward trend that investors believe will continue, which, in turn, perpetuates the downward spiral. During a bear market, the economy will typically slow down and unemployment will rise as companies begin laying off workers.

So how do people react to this kind of market performance? Well, since prices are dropping relatively faster than usual, there are more people looking to sell than to buy, which is what causes the prices to drop so much. This behavior follows fundamental supply and demand models, as there is slightly less demand and much more supply once people begin to sell most of their positions

Another factor of a bear market that influences the way people behave is economic performance. When the economy is performing poorly, there is a strong correlation between negative sentiment and the emergence of a bear market. As such, the emergence of a bear market is associated with a weak economy, since most businesses are unable to record huge profits because consumers are not spending nearly enough. This decline in profits, of course, directly affects the way the market values those assets.

Bear markets are sustained periods when the price of specific assets are dropping across the board. In contrast to bull markets, bear markets cause people to sell more than they are looking to buy assets, which is what causes the prices to drop so much.

Investor Psychology

So you might be wondering why this all happens to begin with. Theoretically, if everyone were to keep buying and the demand for those assets was high, then the prices would also remain relatively and investors would be happy, right? Unfortunately, that’s never the case, as there are too many extra factors which also influence the way that investors behave. The analysis of how investors react to certain market conditions and indicators is known as behavioral economics, and is often used to justify how people behave in bear and bull markets.

One of the most important factors in determining investor psychology during a bear or bull market is their own market bias. Recency bias is the inclination for someone to believe that the market is in a bull run following recent positive price movements. Statistically, there’s no way to prove that the market is any more likely to go into a bull run, but our own psychology would say otherwise.

Recency bias also helps explain retail investor behavior during times of greed or panic. Assets often flow market tops and exit at the bottom, which is exactly the opposite of what investors should be doing. This is because they have a mental inclination to invest during a “positive” time in market performance, which is usually when prices are close to their peaks. As a result you’ll find some investors getting involved too late in the run and end up with large losses as the prices settle down. It’s important to be aware of these psychological factors which could sway you to invest at the wrong time.

Some investors can develop bad investing habits by using recency bias to participate when the market is doing well. This causes people to behave irrationally and introduce positions when prices are near their peaks, resulting in subsequent losses.

Conclusion

Outside of just numbers, charts, and analysis, investor psychology can play a huge role in determining the way that people behave during bull and bear markets. When bull markets emerge and people hear news about the hype and excitement that fills the market, they’ll feel much more inclined to invest and participate in trading when prices are high. Unfortunately, this is a bad investing habit that can lead to larger losses, since there’s no way to statistically prove that the assets will continue to trade at such a high rate. Intelligent investors should be aware of how a majority of these people act, to better understand how to make the best decisions and not make these same mistakes.