Financial markets are in turmoil after the Brexit vote. But Dr Arman Eshraghi says behavioural finance tells us they will recover - albeit to a new normal.
When the news broke, many people in the UK and around the world were shocked to hear that the UK had voted to leave the EU. These feelings of shock and disbelief soon found their way to financial markets.
A very brief period of calm quickly turned to turmoil. The FTSE fell 8% in its lowest one-day slump since the Lehman Brothers collapse of 2008, wiping off £120bn in losses at one point. And the pound tumbled against the dollar by 13% to its lowest level in more than 30 years.
But however troubling this appears, as an expert in Behavioural Finance I take some solace in believing the markets will, in time, recover - albeit to a new normal. Because the behaviour of financial markets isn’t an independent phenomenon. They react, just as people do.
In the same way we experience grief, research shows markets react in distinct stages when major unanticipated news hits. Just as humans tend to denial at first, they are initially most likely to under-react - not entirely sure where they stand.
But once the news sinks in, traders tend to go through the same emotional rollercoaster of powerful, frequently unconscious emotions - from excitement to anger and anxiety – as we all do. Something which can causes the market to overreact.
It is difficult to say for sure, but we may still be experiencing this overreaction following the Brexit vote.
Giving human voice to market activity can be comforting – it makes it easy for us to understand when we say they’re ‘shocked’, ‘surprised’ or ‘angered’.
But it’s crucially important not to read too much into their ups and downs. They can become volatile for all manner of reasons and it’s not just humans driving markets these days.
The way they behave is also likely to be affected by the spread of automated trading, ‘dark pools’ or complex financial products.
The coming days, weeks and months will be rocky as the global financial community – like us all – learns of, and comes to terms with, what’s on the table for the new UK-EU relationship . But, ultimately, financial markets will come to accept change, as the dust begins to settle.