Investor Psychology, Market Sentiment and Stock Price Volatility: A Behavioural Finance Perspective

Abstract

Traditional financial theory is substantially based on the assumption that investors behave rationally, process available information efficiently, maximise utility, and make investment decisions after objectively evaluating risk and return. Financial markets, however, frequently display patterns such as excessive trading, speculative bubbles, panic selling, momentum, overreaction, underreaction, volatility and persistent investment mistakes that cannot always be explained adequately through conventional rational-choice models. Behavioural finance emerged as an interdisciplinary approach combining finance, economics, psychology and decision science to explain how cognitive limitations, emotions, social influence, reference points and psychological biases affect financial decision-making.

This study examines the principal behavioural biases influencing investment decisions and stock-price movements, particularly in the Indian equity market. Major biases discussed include overconfidence, loss aversion, disposition effect, herd behaviour, anchoring, representativeness, availability bias, confirmation bias, self-attribution, regret aversion, mental accounting, recency bias and fear of missing out. These tendencies affect security selection, trading frequency, portfolio concentration, willingness to realise losses and responses to market information. When similar biases operate across sufficiently large groups of investors, they may also affect trading volume, price momentum, reversals, market volatility and temporary deviations of prices from fundamental value.

The Indian equity market provides a particularly important environment for behavioural analysis because rapid digitalisation, mobile trading platforms, low-cost brokerage, simplified onboarding and increased retail participation have transformed the investment landscape. Official securities-market evidence concerning substantial losses among many individual intraday and equity-derivatives traders reinforces the need to understand the psychological factors associated with speculative participation. The study adopts a descriptive, analytical and evidence-based synthesis rather than presenting fabricated primary data. It concludes that behavioural finance complements, rather than completely rejects, conventional market-efficiency theory. It further recommends that investor education move beyond conventional financial literacy to include behavioural literacy so that investors understand their own psychological vulnerabilities and regulators and intermediaries can design more effective investor-protection mechanisms.