The strange thing about market panics is that the arithmetic does not change during them. A company's factories, contracts and customers are the same on the day the price falls 20% as they were the day before. What changes is what people believe other people are about to do.
Losses hurt roughly twice as much as gains feel good
Kahneman and Tversky's work on prospect theory found something that sounds obvious once stated and is deeply strange once you think about it: the pain of losing ₹1,000 is roughly twice the pleasure of gaining ₹1,000.
This asymmetry is not irrational in every context. For most of human history, a loss of resources could be fatal in a way that an equivalent gain was not transformative. Being loss-averse was good survival design. It is simply badly matched to a situation where the correct response to a falling price is often to do nothing.
The bias is not a defect. It is a good rule applied in the wrong environment.
The information cascade
The second mechanism is social. If I have a weak private opinion and I observe many people acting on a strong one, it is individually rational for me to update towards them. If everyone does this, the group can converge on a conclusion that almost nobody had independent evidence for.
The uncomfortable part is that each individual step is reasonable. The cascade is not a failure of any one person's thinking.
Why 'just be rational' is not a strategy
The advice usually given is to stay calm. I do not think this works, because the whole point of the bias is that it operates faster than deliberation.
What seems to work better is removing the decision from the moment. Deciding in advance what you will do — and writing it down — moves the choice out of the panic and into a calmer context. This is the same reason a pilot uses a checklist rather than judgement during an emergency.
What I changed my mind about
I used to think of these biases as things other people had. Then I noticed I check things more often when they are falling than when they are rising, which is exactly the behaviour I was describing as irrational in others.
I have written that one down in Things I Got Wrong.