The Rocky Road of the Stock Market

Stock Exchange, Trading Floor, New York

There is nothing more frightening to a new investor than to see the stock market jump wildly in the course of a single day. In minutes, a $100,000 portfolio might gain or lose $10,000 or more. Before you swear off the stock market for good, here are some things to think about:

1) Ask yourself if the value of your companies really changed by ten per cent or more in the course of a couple hours. Unless the company announced a buyout or a bankruptcy, the answer is almost certainly no. Short-term economy moves are usually based on wild fears, excessive speculation, and unfounded rumors. In times of great economic instability, traders look to experts to tell them what to think, and effects are magnified when everyone jumps on the bandwagon.

2) Look at your company, not the market. Does it pay a great dividend? Is it likely to weather a recession well? If you liked it yesterday and nothing has changed, hold firm.

3) Remember that the industry is not a zero-sum game. Traders sometimes become caught up in the notion that when stocks are up by a certain percentage, they will necessarily fall by exactly the same percentage when things get rocky. While this can happen, good stocks are usually worth more as time goes on, both due to inflation and because the businesses grow. There’ll be pullbacks and sudden jumps, but the graph of a fantastic company will trend up over the long haul, and so will the graph of the market-long periods of stagnation notwithstanding.

4) Realize that the market is significantly easier to predict in the long term than the short one. People who tell you they know what the market will do tomorrow or next week are usually lying. But it’s a fairly good bet that a very depressed market will go back to normal in a month or two and a super-inflated one will return to earth. The same will go for individual stocks. The principle is known as reversion to the mean.

5) Be aware that occasionally there is nowhere to go but up, and vice versa. During the 2009 stock crash, people started asking an absurd question. Could the stock exchange go to zero? When you hear that question being asked, take all your money and catch stocks with both hands. Can they actually think people would stop buying groceries or using gas? A single stock may go to zero, but not the marketplace as a whole. That is why some diversification is essential.

During the preceding tech bubble, people talked about how earnings did not matter. They spoke about a new paradigm, and how it was different this time. Here is a helpful hint: When Allen Greenspan or somebody like him begins talking about irrational exuberance, it is time to think about selling.

6) If stock market volatility makes you sick to your stomach, ask yourself why you are still on the market. Some people are able to take market changes in stride. For others, the thought of a reduction is so frightening they lose weight, develop ulcers, and become deeply depressed. And when they have a gain, they get so excited they jump the gun and miss most of it. If you find yourself on an emotional roller coaster that matches the market’s gyrations, consider lowering your exposure or getting out altogether.

While the individual and the bold can make a great deal of money in the current market, it is not worthwhile if your peace of mind is ruined and your quality of life trashed. The point of trying to earn money, after all, is to make your life simpler.

The world probably won’t end as you’re gone. Don’t read the stock quotes, don’t assess the market-just take a break. Most studies reveal that people who only check their portfolios two or three times per year do better than those who snore.

Conclusion: Learning to handle stock exchange changes with equanimity can improve your financial picture considerably. Extremes of all sorts tend to fade out in time, so avoid rash moves at all costs.

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