TRUMP’S TARIFF THREATS, BEHAVIORAL BIASES AND THE RESULTANT MARKET VOLATILITY

The 2025 tariff threats from President Trump revealed behavioral biases which resulted in major market instability through loss aversion and herd behavior. The S&P 500 index dropped more than 10% during two days after Liberation Day tariff implementation which resulted in a $6 trillion market value loss (McGeever, 2025). The market volatility increased because investors made decisions based on their emotions during this time (Kimmins, 2025). The bond market along with the world markets strongly opposed Trump's tariff increase because this policy created extensive financial instability (Kimmins, 2025). The events demonstrate how behavioral biases strongly affect financial markets when there is policy uncertainty.

Loss Aversion

(Kumar and Goyal, 2016) asserts that diverse inconsistencies of behaviour causes distraction from rational and logical decisions by investors and violate the standard financial theory. (Tamplin, 2025) strongly supports this by stating that fear, loss aversion, and herd mentality all trigger panic selling. Research in psychology and behavioral finance has shown that people feel the pain of losses more intensely than the pleasure of gains (Tamplin, 2025). This is why the investing community often overreacts to bad news even when the situation does not lead to this.

Overreaction Bias

According to (Thaler, 2015), markets overreact to new information even if there is no change in the fundamentals. The market behavior over recent weeks reflects this bias, which is most evident with the Tariffs threats. According to (Gibson, 2025) the Dow Jones Industrial average dropped by 300 points after the announcement of tariffs and there was no other reason to justify this sizeable drop. (Gibson, 2025) further stated that there were initial concerns over a potential trade war by more that two thirds of the Dow Jones Equity Board, the markets, however experienced a rebound after further analysis. (War, 2025) maintained that the initial market sell-off and subsequent recovery indicated that institutional investors had already discounted a certain level of trade tension; however, this changed after the assessed tariffs levels came in higher than anticipated in many key sectors which triggered more panic.

Herd Mentality

As volatility continued to build in the agriculture, stock markets and even the bond markets, herd mentality behaviour was seen to be distinctly displayed. Investors largely felt that they had to follow what the entire market was doing; to sell stocks in the industries that were implicated to be adversely affects, without really analyzing the market conditions for themselves (Tamplin, 2025). Investors often exhibit herding bias observes (Kumar & Goyal, 2016), where financial decisions are based on collective market movements rather than rational evaluation of assets.

More recently in March, the U.S. administration imposed 25% tariffs on imports from Canada and Mexico, alongside increasing tariffs on Chinese goods (Al Jazeera, 2025). Further, the world's most followed equities index, the S&P 500, lost $1.7 trillion due to a stock market meltdown sparked by fears of an economic slump (War, 2025). (Al Jazeera, 2025) further reiterated this position by stating, the market selloff comes as Trump’s back-and-forth tariff announcements have unnerved investors and stoked fears that the US economy could be headed for a major slowdown, or even a recession.

Behavioral Finance and the Efficient Market Hypothesis

The tariff turmoil serves as a reminder that real-world markets are not efficient. While Efficient Market Hypothesis suggests that all information is reflected in asset prices (Thaler, 2015), behavioral biases indicate the limits of the theory. Fear, uncertainty, and cognitive shortcuts can delay or distort the reflection of new information, which leads to temporary inefficiencies (Fama, 1970). The Tariff scenario showcased the market's overreaction and behavioural bias by temporarily inflated volatility beyond what would be expected by rational economic models, confirming (Kumar and Goyal, 2016) views that such biases can lead to irrational investment choices, particularly during periods of heightened uncertainty. However, the good news is that such deviation from efficiency also creates opportunities for disciplined investors who can act opposite to such behaviours.

References 

Al Jazeera (2025, March 11). Why Trump’s tariff chaos sparked stock market meltdown and recession fears. Al Jazeera. https://www.aljazeera.com/news/2025/3/11/why-trumps-tariff-chaos-sparked-stock-market-meltdown-and-recession-fears

 

Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2), 383–417.

 

Gibson, J. (2025, February 4). Dow Jones recovers footing after tariff threats turn up empty. FXStreet. https://www.fxstreet.com/news/dow-jones-industrial-average-holds-steady-as-markets-brush-off-tariffs-202502041728

 

Kimmins, L. (2025, May 12). "Trump was forced to back off": Even Fox Business reporter thinks President caved on China tariffs. The Daily Beast. https://www.thedailybeast.com/trump-was-forced-to-back-off-even-fox-news-is-convinced-president-caved-on-china-tariffs

 

Kumar, S., & Goyal, N. (2016). Behavioral biases in investment decision making – a systematic literature review, Qualitative Research in Financial Markets, Vol. 7 Issue: 1, pp.88-108, https://doi.org/10.1108/QRFM-07-2014-0022

 

McGeever, J. (2025, May 13). Trading Day: No “trade truce” hangover, party continues. Reuters. https://www.reuters.com/markets/global-markets-trading-day-graphic-pix-2025-05-13/

 

Tamplin, T. (2025, March 21). How Panic Selling Damages Your Portfolio (And What To Do Instead). Forbes. https://www.fobes.com/sites/truetamplin/2025/03/21/how-panic-selling-damages-your-portfolio-and-waht-to-do-instead/

 

Thaler, R. H. (2015). Misbehaving: The making of behavioral economics. W.W. Norton & Company

 

War, T. (2025, April 8). Trade War Escalation Triggers Dramatic Dow Jones Volatility. Discovery Alert. https://discoveryalert.com.au/news/trade-war-tariff-market-implications-2025/