What to do the next time the market drops 1000 points in a day.
Article originally posted here by Paradiem
February 5, 2018, the Dow Jones Industrial Average dropped 1,175 points to mark the worst one‑day drop in the history of the market.[1] It made all the headlines, but what really happened?
In reality, the market was down 4.6 percent.[2] Not fun, but within the realm of possibility of what one could expect on occasion. The challenge is, when we see headlines like this, we often misunderstand or are confused by what is actually happening versus what is being reported.
One of my favorite phrases is “surprise is the mother of panic.” When something happens that we never expected, we react in a way that could be detrimental to our long‑term outcomes. This is why knowing the typical volatility patterns is important.
Every day the market moves, but that doesn’t mean you need to take action. When you begin to understand the typical volatility of markets, it can set a framework giving you the ability to ignore the noise and operate from a place of peace; knowing you are exactly where you should be for your long‑term perspective. As Mark Twain once said, “History doesn’t repeat itself, but it rhymes.”
The first thing you need to know is the word “correction.” It is defined as a drop in the market of 10 percent or more.[3]
The talking heads in the media will focus on the market being down, but it might only be down seven percent. Once the drop exceeds 10% the hysteria usually increases, because now they can add the word “correction” in the headline to scare people even more.
What they fail to tell you is that corrections are very common. They happen about once a year.[4] As a matter of fact, the average intra‑year correction for the stock market over the last 30 years is 14 percent.[5] And, 74 percent of years end positive.[6]
Just because the market is in a correction doesn’t mean that you need to do anything. It means that the market is behaving the way it has almost every single year.
The second word you need to know is “bear.” A bear market is defined by a drop of 20 percent.[7] Typically, a bear market will occur in about one out of every five years.[8] The challenge is getting the media to agree when a bear market has occurred, especially if it doesn’t serve their headlines.
Many people are reporting that we haven’t had a bear market since 2008. It really depends on what story you want to believe. The market was down more than 20 percent for large companies back in December of 2018[9], and small companies and international companies have experienced two to three bears over the last 10 years.
The reason the talking heads continue to say we haven’t had a bear market, is because the market didn’t close more than 20 percent down. It was more than 20 percent down during the day, but when the final bell rang it was only down 19.8 percent.[10] It serves their fear inducing headlines to say we haven’t had a bear market. The pain of that 20 percent drop was a very real event to everyone. Instead of looking for the next big drop, consider that the bear market you’ve been told to expect already happened in 2018.
The third thing to understand is, no matter how uncomfortable a correction or a bear market may be, to succeed, you must survive them. The headlines are trying to get you to take action, action that may ultimately be detrimental to your long‑term plan. My favorite phrase when it comes to investing is, “Don’t just do something, sit there.” In the middle of scary headlines, in the middle of extra volatility, the tendency is to feel like you need to do something.
Over the last 30 years, there have been eight bear markets. Five of them started, found their bottom, and began their climb back in less than five months. The last two bear markets have recovered all of their losses in a year or less.[11]
The challenge with trying to avoid a bear market is you don’t make one decision, you make two. You decide when to get out, and then you decide when to get back in. I have yet to see any individual or any professional organization consistently get this right. Most investors get this wrong and it costs them growth in their investments.
As much as it feels like action would be the best, the statistics and the reality show, the best investors achieve success by riding the volatility out until it passes.
When I came home from school as a young kid, I would turn on afternoon TV. They always had those public service announcements that ended with the phrase, “The More You Know.” I believe the more you know about volatility, the better an investor you will become.
You will be in a better position to make decisions for the long term, knowing that you own stock in high‑quality companies in America and around the world. You can have confidence that these companies are managing themselves for long term profits, and the daily volatility of the markets has nothing to do with the long-term strategies these companies are using to grow their business. Do yourself a favor and ignore the daily news.
At Paradiem, we hate “investing” and think you should too! We are not just investors; we are OWNERS and we believe WHAT you own and WHY you own it is a much more important consideration. If you would like more information on the importance of understanding what you OWN, email info@paradiem.org with the subject “Ownership” or give us a call at (985) 727-0770.
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[1] https://www.cnbc.com/2018/02/05/dows-nearly-1600-point-plunge-marks-its-biggest-one-day-point-drop-ever.html
[2] https://money.cnn.com/2018/02/05/investing/stock-market-today-dow-jones/index.html
[3] https://www.investopedia.com/terms/c/correction.asp
[4] https://www.fool.com/knowledge-center/6-things-you-should-know-about-a-stock-market-corr.aspx
[5] https://www.cnbc.com/2018/12/20/when-the-market-is-in-correction-tech-tends-to-get-pummeled-the-worst.html
[6] https://www.icmarc.org/prebuilt/apps/downloadDoc.asp
[7] https://www.investopedia.com/terms/b/bearmarket.asp
[8] https://www.aaii.com/journal/article/stock-market-retreats-and-recoveries
[9] https://www.cnbc.com/2018/12/31/stock-market-wall-street-stocks-eye-us-china-trade-talks.html
[10] https://www.investopedia.com/a-history-of-bear-markets-4582652
[11] https://www.macrotrends.net/2324/sp-500-historical-chart-data