The Mistake Impatient Investors Must Avoid Right Now

It's too easy to expect a quick resolution to the market's worries.

Feb 8, 2014 at 11:31AM

The S&P 500 (SNPINDEX:^GSPC) has finally given many investors what they've been seeking out for a long time: a reasonably large dip in price. Yet with the stock market having posted a sharp recovery in the past few days, many investors have concluded that the long-awaited correction has already run its course. As tempting as that thought might be, a short but sweet mini-correction is a bit too convenient for investors to count on right now. Whether it's now or at some point in the near future, stocks will eventually reassert a choppier trading pattern that includes far more ups, downs, and bumps in the road than we've seen in recent years.

Image source: Wikimedia Commons, courtesy Katorisi.

The argument for why the correction might be over
One reason why bulls think that stocks might already have reestablished their upward move is the speed at which investor sentiment turned on a dime. After last year's huge gains in the S&P 500, investors immediately started selling when 2014 began, with figures indicating some of the biggest outflows from stock mutual funds in years. That behavior makes a lot of sense, as investors have tax incentives to hold off on taking profits until after a new year begins in order to get an extra year to pay capital gains taxes. But it also points to a short-term phenomenon rather than a long-term shift in attitudes about the market at large.

At the same time, much of the negative news that has happened over the past month is also explainable as one-time events. Already, we've seen cold weather blamed for poor economic data on various fronts, including today's employment report. In light of how many head-fakes the market has given investors over the past five years of the bull market, being skeptical of negative news is a natural reaction.

Why you should still be cautious
Of course, assertions that the economy will get better can help hold the market up in the short run. Eventually, though, the numbers have to prove those assertions, or else the resulting loss of confidence will send stocks back downward again.

We've seen that play out with many individual stocks in recent months. Investors were willing to bid up shares of Twitter (NYSE:TWTR) after its IPO, despite uncertainty about whether it could actually deliver fast enough growth to justify a rising valuation. Yet when the company announced earnings earlier this week, shares plunged as Twitter couldn't produce the profits that investors wanted to see. Similarly, 3D Systems (NYSE:DDD) has fallen by almost a third since the beginning of the year, with a big part of that decline coming in a single day after the 3-D printer specialist gave disappointing sales and net-income guidance -- despite expecting impressive revenue growth this year and well into the future.

Impatient investors always want to get losses over with quickly so that they can get back to their winning ways. That's great when it happens, but those who remember the long and drawn-out bear markets of the 1970s know that the stock market doesn't always give investors what they want. Don't rely on this correction being over, and stay smart about managing your risk accordingly to avoid any unfortunate mistakes.

Keep your balance
Yet it's also the wrong answer to get out of stocks entirely. Millions of Americans made that mistake five years ago and missed out on huge gains. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends 3D Systems and Twitter and owns shares of 3D Systems. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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