CHAPEL HILL, N.C. (MarketWatch) — You shouldn’t let the stock market’s recent volatility scare you away from the stock market.
That’s for at least two reasons: There’s no statistical support for the notion that higher volatility leads to lower returns. In any case, the stock market’s recent gyrations actually aren’t all that unusual — appearances to the contrary notwithstanding.
Consider first the raw data: In 11 of the 14 trading sessions so far this month, the Dow Jones Industrial Average
has closed up or down by at least 100 points. While that seems like a high proportion, it isn’t particularly rare. There have been 87 other occasions over the last decade with just as much volatility — about once every six weeks, on average.
Furthermore, given the Dow’s lofty level around 18,000, a hundred-point change isn’t very noteworthy in percentage terms — less than 0.6%, in fact. This is particularly important for market veterans like me to remember, since we cut our eye teeth when the Dow was a lot lower. When I began editing the Hulbert Financial Digest in 1980, for example, a 1% change in the Dow translated to just 8 points — versus 180 today.
And if we focus on percentage changes, which of course is the proper thing to do, recent volatility isn’t particularly unusual. There have been five days this month in which the Dow closed up or down by at least 1% — a frequency that over the last century has happened an average of one every four trading sessions.
The better reason not to sweat the market’s recent gyrations, of course, is that the market on average doesn’t perform significantly differently following stretches of above-average volatility. The accompanying table reports the historical tendencies whenever the market has been as volatile as it has over the last three weeks, or more — versus when it has been less so.
As you can see from the accompanying table, the return differentials are tiny. They don’t come close to being significant at the 95% confidence level that statisticians often use to determine if a pattern is genuine.
The bottom line? Recent volatility is neither particularly unusual nor a source of undue concern about the market’s prospects.
What if you nevertheless find the stock market’s volatility intolerable and are therefore thinking of taking money out of equities? I have two suggestions.
The first falls in the “don’t get mad, get even” category: Put limit orders well below the market for stocks on your buy list, and well above the market on issues you already own. Upon doing that, you may very well find yourself secretly yearning for more rather than less volatility — since it increases the odds of buying attractive stocks at far lower prices, and selling your current holdings at much higher prices.
My second suggestion: Pay no attention to what the market does on a day-to-day basis. That’s easier said than done, since you will still want to log in to the MarketWatch website to read your favorite columnists.
But ignoring the market does have a desirable consequence: Academic research has found that, as you reduce the frequency with which you look at what the market’s gyrations are doing to your net worth, the greater your willingness to remain invested in equities.
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