The Rally Trap: Why Two Good Days Are the Most Dangerous Moment in a Crisis

The most dangerous moment in a market crisis is rarely the crisis itself. It is the first two or three days of recovery, when the emotional environment shifts just enough to make action feel warranted again. The drawdown phase produces a kind of paralysis in many investors: the situation feels too uncertain to act, so they hold. The recovery phase dissolves that paralysis and replaces it with a different set of impulses, some toward relief-driven complacency, some toward regret-driven re-entry, and some toward the temptation to “lock in” gains that were not actually gains but recoveries of losses. All three impulses carry real portfolio risk.

This is precisely where many Canadian investors sit this morning. The S&P 500 has recovered roughly 5% across two sessions. The TSX has added more than 1,500 points since Monday’s close. Gold is holding near $4,747. The ceasefire signals are real enough to move markets but unverified enough to reverse tomorrow. And tonight, a presidential address to the nation will either accelerate the recovery or undercut it. The behavioural challenge is not abstract. It is immediate, and it has a specific shape depending on what an investor did or did not do during the past five weeks.

The Re-Entry Dilemma

Investors who sold equity holdings during March’s drawdown, whether partially or fully, now face one of the most psychologically uncomfortable situations in personal finance. Markets have moved higher in their absence. The prices they sold at are now below current market levels, meaning re-entry requires buying back at a loss relative to where they exited. Research in behavioural finance consistently shows that this dynamic, known in the literature as the disposition effect’s mirror image, causes investors to defer re-entry indefinitely, waiting for prices to come back down to their exit point before acting.

The problem is that prices may not return to the exit point. The 2025 tariff-tantrum correction is a useful reference. The S&P 500 fell approximately 19% in spring 2025 before recovering sharply when the most severe tariff threats were paused. Investors who sold near the bottom and waited for a “better entry” frequently missed the initial recovery, which was the period of the largest single-day gains. Hartford Funds research quantifies the cost of this pattern precisely: missing the market’s 10 best days over a 30-year investment period cuts cumulative returns in half. Missing the 30 best days reduces returns by 83%. Critically, 78% of the market’s best days occur during bear markets or the first two months of a bull market recovery, the exact window in which investors who sold are most likely to be sitting on the sidelines.

The Complacency Risk for Investors Who Held

Investors who maintained their positions through March’s drawdown are in an objectively better position today than those who sold. But the two-day rally carries its own behavioural risk for this group: complacency. After weeks of monitoring a declining portfolio and resisting the urge to act, the recovery feels like vindication, and vindication has a way of relaxing the disciplined posture that produced it.

The risk is that investors who held through a 7% decline interpret a 5% recovery as evidence that the crisis is resolved, when in fact the Strait of Hormuz is still closed, the IEA is warning of a worse supply crunch in April, and tonight’s presidential address could produce a materially different market environment by tomorrow morning. UBS’s Chief Investment Office, in its March 13 crisis note to clients, described the core behavioural challenge precisely: “we do not have control over how markets behave, but we can decide how we respond. In times like these, it’s tempting to succumb to action bias, a behavioral bias that gives us a strong urge to take action to assert control.” The prescription in their view was identical whether markets were falling or recovering: stay invested, maintain the plan, and resist the urge to mark the resolution of a crisis before it is actually resolved.

What the Research Says About Geopolitical Shocks

The historical pattern of geopolitical shocks and market recoveries is consistent enough to be instructive, even if individual events vary. Defiant Capital Group published an analysis in mid-March drawing on 40 major geopolitical events spanning 85 years of S&P 500 history. The finding: across those events, the index lost an average of 0.9% in the first month but recovered to gain 3.4% over the following six months. The 2026 Iran war has already produced a larger first-month decline than the historical average, which either reflects the genuine severity of the Hormuz closure or suggests markets have overpriced the tail risk. Either way, the research implies that the investors most likely to benefit from the eventual resolution are those who remained invested through the most uncomfortable period.

The qualifier that matters most is the one Defiant Capital included in its own note: “geopolitical shocks tend to produce short-term volatility rather than permanent damage.” The phrase “tend to” is doing significant work. The 1973 OPEC embargo is the event most frequently cited as a counterexample, a geopolitical shock that produced lasting structural economic damage rather than a temporary dislocation. The key variable distinguishing temporary from structural is the duration of the supply disruption. The IEA’s warning that April will be twice as severe as March is the data point that makes the structural risk real rather than theoretical. That risk has not resolved. Two good days do not resolve it.