The stock market is driven by human psychology. Fear motivates people to sell in a panic, so they often sell low when stock prices fall. Hope, or greed if you prefer, also drives the markets.
That is why people see a rising stock and invest, even though its price may be overly valued. Behavior in investing is seldom rational. Buy low sell high is an easy rule, but one robots could follow effectively, and not human beings. People behave according to want, need, fear, herd mentality, and just plain ignorance too.
Motivation is everything when it comes to driving the market, and one of the primary causes of the economic downturn, is that people also develop a herd mentality. They see a bubble building, but cannot identify that every bubble has to burst.
It happens again and again. Of course other behavioral factors affect the market as well. When very wealthy people are insulated from the real world, they forget, or never knew, that people out there have many obstacles to earn enough money for housing loans. Bundles and swap deals leave people who can’t really afford loans to be lured into them anyway. Lending on easy credit almost always leads to disaster because those brokers making the deals are profiting and seeing no end in sight.
Savvy investors know that every bubble has to burst. They know that you have to buy and hold, and only invest as much as you can afford to lose. They know that in the long run, stocks will rise and fall, and very solid companies stand the test of time. If they are in a situation to do so, smart investors pre place orders to buy on dips, and sell on 52 week highs. Over time the portfolio grows, albeit modestly, but steadily.
Of course this is not a hard and fast rule. Some enormous companies with record profits will still die off eventually. Think of giant oil corporations. Eventually we will run out of fossil fuels, but the smart energy companies are switching over to slowly invest into renewable energy. You don’t have to lose sleep about the most profitable companies on earth being likely to lose billions. Even B.P., made record profits in spite of the disastrous oil spill in the U.S. gulf.
Speaking of oil soaked birds and marine animals, another behavioral aspect of the stock market involves the reality that people will often invest in something they support, and/or shun those investments that they feel do harm in the world. So behaviorally, people will either believe some stocks are “good” and some are “evil.” Of course, there is always the case of those who convince themselves that even gambling, cigarettes, oil, and toxins are good investments because they have reasoned out what good is done in the world with these things!
People are not known for their reasoning and rationality when it comes to the world of investing, but over all most people who reign in their fears and hopes, and if they stay aware of these drives, will act upon them and gain.