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Investor psychology expert: Don't get unsettled by this drop, it was not that extreme

A monitor displays the day's numbers as traders and financial professionals work on the floor of the New York Stock Exchange (NYSE) at the closing bell, February 2, 2018 in New York City.
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A monitor displays the day's numbers as traders and financial professionals work on the floor of the New York Stock Exchange (NYSE) at the closing bell, February 2, 2018 in New York City.

The images of the Dow Jones industrial average point drop really caught my eye Friday afternoon. People are measuring the stock market's decline in points, not in percentage terms. Even more, the 600-plus point drop feels like "a lot of points" and "a very, very rare event."

We don't handle rare, negative, extreme events well. They unsettle us. Think earthquakes and hurricanes.

The reality, though, is that today's 2.5 percent decline, while significant, is neither rare nor extreme. Even more, coming atop a relentless 20 percent-plus rise in the market, the drop represents a give back of just the past three weeks.

But therein lies the challenge. The first description uses "System 1 Thinking," while the second requires "System 2 Thinking".

When confidence is weak, we don't have the cognitive bandwidth for System 2 Thinking. We will take hold of whatever feels right to us, even when its wrong.

What concerns me is that the perception that Friday's 600-plus point and this week's 1,090 point drop, is an extreme event that could easily turn into a market crash on Monday. Given current mood, System 1 perceptions could easily trump System 2 facts.

I would pay close attention to Friday's news and the coverage of market action in weekend papers like USA Today. The media follows mood. If it is all about the points, and not the percentages, we could be in big trouble here.

As always, not wishing it. But the mood backdrop matters here.

Peter Atwater is the president of Financial Insyghts and an adjunct professor in the Economics Department at The College of William & Mary. He writes and speaks frequently on the role of confidence in decision making.