No. of Recommendations: 3
If I understand correctly, people are dumping dropping stocks to save what gains they can, while an equal number of people are buying at discount. Later, when the stocks pick up, people are again jumping in, allowing an equal number of sale-buyers to sell and save their gains.

While no one really has proof that what you observe is caused by this, its is a very reasonable guess.

I assume they will take the same ride, but perhaps the stocks in the fund will be balanced by other stocks raising?

Index funds, or any kind of funds, benefit from diversification in this manner, yes. In a bear market, some stocks will drop more, some will drop less, and some will still go up. Holding a wide swath of the market means that you are greatly greatly reduces your chances to end up squarely on the worse side of the equation. Of course, it also greatly reduces your odds of ending up squarely on the good side of the equation - but that's the point, it reduces swings.

It is a perfectly logical and correct reasoning for most people to want to moderate the good and the bad somewhat, by guaranteeing market (or near market) performance.

If I missed your question, let me know :)
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