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Types of Traders Who Panic and Historical Examples

In this lesson, we will explain in detail the different types of traders and how they respond to unexpected price fluctuations in the market.

There have been multiple instances in the past when the market has suffered historic crashes due to large numbers of investors losing their clear judgment to fear and panic.

Whether you continue to profit or become a losing trader even in a panicked market depends largely on a split-second decision.

Trader Types Categorized by Their Reactions During Panic

When the market fluctuates sharply and unpredictably, investors who panic typically react in the following ways.

• Panic selling: A type of trader who realizes unnecessary losses driven by fear or anxiety rather than rational judgment.

• Freeze type: A type of trader who goes into shock due to unexpected losses and is unable to press the ‘close position’ button when they should be cutting their losses.

• Reckless buying (revenge trading): A type of trader who, in a fit of anger and in an attempt to recoup losses immediately, increases their position size or buys more at unfavorable prices.

Let’s explore some real-life examples of these types of traders.

February 2020: Panic selling triggered by the COVID-19 shock

From February 2020, lockdowns resulting from the COVID-19 pandemic spread across the world. The uncertain outlook caused the global economy to plummet.

The market decline began in late February, and within just four weeks, the US S&P 500 Index fell by more than 35% from its recent all-time high, at an unprecedented rate.

[Source: TradingView “Coronavirus (COVID-19)”]

The uncertainty about the future fuelled unrelenting selling pressure, leading to a chain reaction of sell-offs.

Trends in World Stock Markets During COVID-19

 The trigger of the COVID-19 shock was the mandatory lockdowns imposed by countries worldwide to prevent the spread of the virus.

In the face of an uncertain economic outlook, investors sold off significant assets to secure cash, causing a market crash.

As an unusual event, the stock market triggered Circuit Breakers four times only in March, 2020, what activated only once in 1997.

Caught in Panic Selling in March 2020

As COVID-19 spread and lockdowns began, markets fell further each day. K, a beginner trader, watched his losses grow for weeks while social media filled with posts declaring "the market is over."

On March 23, he finally broke. Seeing others around him sell and cash out, he sold everything too. That date turned out to be the exact bottom, and the market began recovering just days later.

[Source: Wikimedia Commons]

Why did the COVID-19 shock occur?

The main reason for this crash was a combination of fear, such as group bias, and came from thinking “I don’t want to lose my assets anymore” and “Everyone is selling so I should do it too”

1. A cycle of uncertainty and fear

With no reliable information on the virus or when the economy would reopen, traders faced intense stress. Fear pushed them to sell and hold cash, and that selling triggered more selling, spiraling the market downward.

2. Herd mentality[1] 

People feel safer as part of a group, especially under high stress when calm judgment is hard. Seeing others sell and charts plunging made individual investors follow suit.

3. Algorithmic selling[2] 

Automated systems, programmed to force-liquidate positions once prices hit certain levels, accelerated the decline further, intensifying the same selling cycle.

2010: The Flash Crash

The Flash Crash of May 6, 2010, exposed the fragility of modern algorithmic trading. The Dow Jones fell about $1,000 in roughly 36 minutes before rapidly recovering, according to a joint CFTC-SEC report.  (According to a joint report by the CFTC and SEC[3] ).

It was triggered by a $4.1 billion futures sell order from an investment firm, which set off a chain reaction among HFT (High Frequency Trading) algorithms; even blue-chip P&G crashed 37% instantly, and over 20,000 trades were executed at prices more than 60% off normal.

[Source: LinkedIn “The history of 2010 Flash Crash” ]

The circumstances leading to the Flash Crash

The event is believed to have stemmed from large-scale automated futures selling combined with "spoofing," illegal manipulation via large sell orders placed far from market value and cancelled before execution.

As HFT algorithms detected the abnormal selling, they halted trading and joined in selling, driving the chain reaction that sent the Dow down about 9% in minutes.

Caught in the Crash: K's Case

K, a novice trader, watched his screen fill with red as the chart plunged. He hovered over "close position" but couldn't click, thinking "it's bound to bounce back." Moments later, his losses had ballooned by more than 50%.

A near-$1,000 swing in minutes exceeds normal human cognitive limits, and the record of over 20,000 anomalous trades shows other traders “frozen” the same way.

The Result was Not a Strategy

The market recovered within about 30 minutes, and prices had regained roughly half their losses by the time K snapped out of it. Even though he wasn't left with a financial loss, he still failed to follow his own strategy.

The Phenomenon of Freezing (Stop Thinking)

When traders face an unexpected crisis, they react with a “fight, panic, or freeze” response.

• Panic from overloaded information

During a flash crash, figures on trading screens and chart movements change at speeds that exceed usual tracking and information processing capabilities.

• Mental Shutdown

The brain fails to comprehend the unfolding events, leading to panic driven by the fear of loss. Consequently, traders become unable to execute orders or liquidate positions, literally freezing in front of their screens.

Mechanisms Exacerbating the Liquidity Crisis

To stop a market crash, buyers must step in to "buy the dip" as prices fall.

However, during a flash crash, traders who freeze fail to take action. Even when prices drop to levels that would normally be considered undervalued, these traders hesitate and withhold their buy orders.

This lack of buying activity drains market liquidity, which in turn triggers further automated stop-loss executions and fuels additional panic selling.

How to Avoid Panic and Prevent Losses

For traders prone to freezing during panic, the following measures are effective.

• Setting Stop-Loss Orders

When placing new stock or forex trades, determine your stop-loss points in advance or place the stop order at the time of the initial trade.

Since the system handles settlements automatically, you can avoid incurring unnecessary losses.

• Reduce position sizes

Understand your risk tolerance and trade only with an amount you are comfortable risking. Trading with surplus funds is crucial for avoiding panic.

• Diversity your investment

Diversify your portfolio to mitigate the shock of losing assets in a sudden market crash. By spreading your investments across different asset classes, you ensure that a downturn in one specific area does not have a major impact on your overall assets.

Conclusion

• Panic selling and freezing look different, but both come from the same cause: fear and overwhelming judgment in the moment.

• The solution for both is the same: decide your exit points before you’re afraid, so the decision is already made once panic sets in.

The next lesson covers the opposite problem, what happens when traders get angry instead of afraid.