Emotions and Markets

The gap between what we intend to do and what we actually do is one of the enduring puzzles of behavioural science. Most experienced investors know they should stay disciplined during volatility, yet many struggle to do so when markets fall sharply. Knowledge alone rarely changes behaviour. George Loewenstein’s concept of the “hot–cold empathy gap” explains part of the problem: when calm and reflective (a “cold” state), we underestimate how powerfully emotions will take over in a “hot” state of fear or excitement. We imagine we’ll stay rational during a sell-off, but our anxious, future self often reacts very differently once losses feel real. Market design amplifies this effect: constant feedback mimics gambling rewards, losses feel twice as painful as equivalent gains, and social comparison keeps emotions on edge. The difficulty isn’t ignorance, it’s biology. Emotional responses can bypass conscious reasoning altogether. That’s why effective strategies focus less on education and more on structural safeguards, for example, reviewing portfolios less frequently or using pre-agreed decision rules that activate only under certain conditions. Such measures help investors protect themselves from their own emotional reflexes.