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Time to Get Nervous?

The Dow Jones (INDEX: ^DJI  ) fell on Friday. It also fell on Thursday. And the day before. It fell every day last week, in fact. It also fell the Friday before that. Two weeks ago, it fell for six days straight.

Add it up, and the Dow has declined in 12 of the last 13 trading sessions.

If that sounds like a lot, it is. Going back to 1928, the most number of times the index has fallen in any 13-day period is 12. It's done that two-dozen times, so recent losses didn't break any records. But if the Dow closes down today (it's up so far today), it will be the longest losing stretch since before the Great Depression.

The Dow is only down about 7% from its high in early April, and is still up for the year. But a long string of declines makes investors nervous. And we're a fickle bunch: There's a joke in investing that the definition of a blink of an eye is the precise amount of time it takes pundits to go from "bullish" to "Dear God, sell." Add to it that people naturally look for patterns (and assume patterns will keep repeating), so that when stocks fall day after day, we worry.

In his excellent book Your Money and Your Brain, Jason Zweig shows how recent results affect how investors feel about risk. In the most simplistic terms, neurons that hold memories about rewards and punishments from recent events are more active than those of the distant past. "Because your most recent experience carries more weight," Zweig writes, "these neurons evaluate the likelihood of a gain based mainly on the average result of your last five to eight attempts at making money -- with almost all the influence coming from your last three or four tries."

With stocks down almost every day in the last two weeks, you can see why the current mood, particularly among media analysts, is so glum. "Brace for more selling," a headline on a major news site read Sunday evening. No journalist has ever successfully predicted weekly market moves, but who cares? Stocks have fallen so frequently lately that no one will question the logic.

Whenever there's a long string of market declines or a big sell-off that makes you want to scream "uncle," I remind myself of an important piece of context: all of the past market declines that we don't even remember, or at least don't talk about, anymore.

There was last summer, for starters. From April to September 2011, the Dow fell more than 16%. In came the usual litany of predictions telling investors to sell everything. "I definitely believe the sky is falling," said noted analyst and CNBC guest Dick Bove. "You can call me Chicken Little if you'd like." Stocks bottomed weeks after his call, and went on to rally nearly 25%.

Then there was 2010. The Dow fell 14% from April to July that year. Google searches for the phrase "double dip recession" went up 20-fold. Little came of it. Stocks jumped 30% within a year.

Few investors remember the 8.5% sell-off in March 2005, but it was a big deal at the time. As inflation picked up early in the year, Fed Chairman Alan Greenspan told Congress he felt interest rates were still "fairly low." By most accounts, those two words made investors think the Fed would jack up interest rates and push the economy into recession. A recession eventually hit, of course, but not for years, and not because of high interest rates. After the 2005 pullback, the Fed hiked interest rates slowly, the economy boomed for another three years, and the Dow rallied more than 40%.

Most remember 1998 for the roaring stock market, but the Dow actually fell 19% in the middle of the year -- then one of the biggest declines since the Great Depression. Russia defaulted on its debt, a big hedge fund blew up, and everyone freaked out for a few weeks. Then they got over it. Stocks surged.

These stories should remind you of two important points.

One, market pullbacks happen. They happen every year. They're a perfectly normal part of how investing works. They don't mean the world is coming to an end. They're just something markets do from time to time. "[P]eople see the next 2008 in every setback," blogger Josh Brown wrote last year. There's Zweig's point about short-term memory clouding our view of risk. But the truth is, the overwhelming majority of pullbacks are mild and short-lived. That's why most don't even remember them.

Two, and more important, those pullbacks can provide some of the best buying opportunities. You will never convince the average investor, amateur or otherwise, that you should get nervous when everything feels great, and bullish when it hurts so bad you can't open your brokerage statements -- but that's exactly how successful investing works. How ironic it is that we fear the next market decline without remembering that the last one gave us a chance to earn a 25% return within months.

"What is comfortable is rarely profitable," investor Rob Arnott once said. Has the recent pullback made you uncomfortable? Good. It tells you something about what to expect tomorrow.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (5) | Recommend This Article (26)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 21, 2012, at 3:04 PM, wolfman225 wrote:

    Thanks for the perspective. If it weren't for the 24hr news cycle needing a constant supply of fresh material to anguish over, I think we'd see much less chop in the financial markets.

    Personally, I think I'll continue to follow the Fool's most basic advice: Invest with a long-term horizon, buying quality companies with solid fundamentals (some with dividends) and ignore all the noise. It's been shown over and over that active amateur traders achieve much poorer results than even simply buying and holding the indexes. For the majority of us, the best move is to research our choices, make our buys at good entry points (or, in the case of 401K's, set our allocations and contribution percentages) and leave them alone. Checking the performance every 6 months or even annually is sufficient.

    The greatest asset an investor can have is the ability to ignore the short term buzz.

  • Report this Comment On May 21, 2012, at 4:10 PM, Realexpectations wrote:

    Sometime's I think there are pull backs just so some big head honcho can get in at a better price.

    I always think that the actual people that work on wall st. never actually lose anything, even if their business goes under or they lose their job.

  • Report this Comment On May 21, 2012, at 4:11 PM, joaquingrech wrote:


    actually I wrote something similar last year on august when everybody was about to jump out of a window. then it kept going down for a few more months and then later hit almost history highs... anyway... my blog post back then

  • Report this Comment On May 21, 2012, at 4:48 PM, Clint35 wrote:

    Good article Morgan. I would also like to point out that people shouldn't pay much attention to the Dow by itself. There's only 30 companies listed on the Dow so it's not a good indicator of how good or bad the market is doing.

  • Report this Comment On May 21, 2012, at 6:00 PM, bernbern0 wrote:

    Excellent article Morgan and very reassuring. It reminds me of your great eBook, EVERYONE BELIEVES IT: MOST WILL BE WRONG. I love it, and I refer to it often. Especially at turbulent times like these. Keep up the good work. Thank you.

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