Stock market tremors can feel like a roller coaster ride. Even the thought of the market potentially hitting the skids deters many young people from starting to invest to begin with. Others don’t even realize they’re uncomfortable with their investments until the market takes a nosedive. Then they panic and frantically instruct their advisors to sell, sell, sell. It’s perfectly understandable – nobody enjoys losing money.
Why is the thought of stock market swings so unsettling to begin with? It’s usually a lack of understanding about the reasons behind the perceived madness that keeps people up at night. It’s important to know that the markets aren’t these mysterious, totally erratic entities. There are common causes for market gyrations. Understanding the why behind it all will keep you calm and confident during those days that many others are having financial freak outs.
These are the most common reasons for the ups and downs of the stock market:
Human emotion:
Human emotion has a great impact on the markets. How we feel is usually the driving force behind buying and selling. It’s typical to feel disappointed when the market’s down, and to feel delighted when it’s up. The problem is when there are larger fluctuations over a period of time. That’s when most people experience great fear or nervousness about the safety of their investments and react accordingly. Swings in emotion parallel swings in stock prices, often resulting in the acceleration of the underlying market movement.
Couple things to note: First, human emotion and biases are imbedded within all other volatility drivers as well. Second, people’s reactions to the market’s ups and downs can lead to the tendency to time the stock market badly, i.e. the Behavior Gap. Need a little refresher on that one? We’ve got you covered.
Earnings reports:
Quarterly and annual earnings reports are short term figures and estimations about how a company is performing and, oftentimes more significantly, how it’s expected to perform in the future. Remember that the stock market is a forecasting mechanism. Meaning? People buy and sell based off of what they think will happen. These decisions are frequently based off of quarterly and annual glimpses into the inner workings of companies. Earnings reports can drastically drive up or down stock prices because the numbers they present weigh heavily on public opinion.
Federal Reserve policy:
What the Federal Reserve does, or even considers doing, can make the market fluctuate dramatically. People think because the market reacted a certain way to the Fed’s policy changes once, it will react the same way every time. This reasoning makes investors have a knee jerk reaction to any talk of the Fed making policy shifts.
Political developments:
Wall Street is inclined to react to changes in political policy because those policies can have a big impact on the U.S. economy over the long run. Things like corporate or individual tax changes, trading restrictions, and bank regulations can cause sudden spikes or dives in the markets. Regardless of whether these developments are real or rumored, the market will fluctuate in response. Even just the mention of big changes to come can temporarily throw the markets out of whack.
Understand that market fluctuations are natural and unavoidable. Volatility is inevitable in the short term, but not in the long term. Rather than running for cover when the market drops, why not learn how to make the most out of the situation? Think of it as the potential for a great opportunity to put your hard-earned money to work for you. Better yet, regularly review your investments to confirm that they match your tolerance for risk. Be cognizant that investing in a highly volatile market can be riskier than when things are settled down. Remember that you sometimes need to take a step back and look at the long term situation rather than the short term fluctuations in order to resist the herd mentality and gain perspective.
If you’d like to chat more about the markets and your investments, just give us a call.