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Portfolio > Portfolio Construction > Investment Strategies

Don't Panic Over Panic Selling: MIT Researchers

By Ginger Szala

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What You Need to Know

  • The negative connnotations of panic selling may “not always be warranted,” researchers conclude.
  • Investors must get back into the market in time to capture the rebound, but nearly a third of them never return.
  • Panic sales during falling markets are most common among men over 45 with dependents and those who say they have high levels of market knowledge, a study found.

Panic selling is a “rare event,” according to a new study by MIT Sloan School of Management researchers. That said, when it happens, it can impact investment accounts, but not always in the way commonly believed.

In the study, When Do Investors Freak Out? Machine Learning Predictions of Panic Selling, the researchers found that an average of 0.1% of investors are panic selling at any point in time. However — no surprise here — such sales happen more often during large market moves.

Close to 31% of panic sellers never reinvest the money in risky assets, while 58% reenter the market within half a year.

The study’s authors are Daniel Elkind and MIT’s Kathryn Kaminski, Andrew Lo, Kien Wei Siah and Chi Heem Wong.

Who is most likely to “freak out”? Men over 45, who are married or divorced and have dependents. They also describe themselves as having “excellent” or good knowledge of the market.

Typically, they are self-employed, business owners or in real estate. Those occupations least prone to panic selling are paralegals and social workers.

Cost of Panic Selling

Conventional wisdom states that panic selling leads to large losses, and of course it can. But in the study of 296,556 household brokerage accounts between 2003 and 2015, it found that timing is everything.

As the authors state, “calculating the opportunity cost of panic selling over time finds that panic selling is suboptimal if executed in an improving market, but it is beneficial as a stop-loss mechanism in rapidly deteriorating markets.”

Further, performance also depended on when the investor exited, and the duration of the exit.

For example, in its hypothetical study, it found that an investor who liquidated at the beginning of the financial crisis and left the market for 15 months at that time “saved himself from losing another 17%. Holding out for more than 34 months after liquidation, however, would have caused the investor to miss the post-2009 market rally and forgo potential profits.”

The researchers found that investors who made panic sales “achieve only a slightly negative return after they liquidate.” Also, in contrast to overtrading, “investors who made panic sales did so infrequently.”

Finally, the study concludes that the negative connotations of “panic selling” may “not always be warranted. While panic selling in normal market conditions is indeed harmful to the median retail investor, freaking out in environments of sustained market decline prevents further losses and protects one’s capital.”

Ginger Szala

@gingerszalaink

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