Market volatility makes most investors uncomfortable. But given the whipsawing news items that you see nearly every day, you shouldn't be surprised that the stock market can't seem to make up its mind which way to go.
But the biggest problem with such difficult times is that you face the temptation to think that things will always be this uncertain. If you change your proven long-term investing strategy in favor of something that seeks to capitalize on current short-term trends, you could find yourself badly positioned when the next big market change happens -- whichever direction it may go.
Dealing with a market that drives you crazy
Unfortunately, the conflict between bullish and bearish news has never seemed stronger than it does today. Consider just a few examples:
- The downgrade of U.S. sovereign debt suggests that the long-term quality of Treasury bonds is weaker than most assume. Yet since the downgrade, Treasuries have soared, while bearish bets like ProShares UltraShort 20+ Year Treasury (NYSE: TBT ) have gotten crushed.
- Looking backward, many companies are reporting earnings that are beating expectations and showing solid growth. But with stocks like Amazon.com (Nasdaq: AMZN ) , Ancestry.com (Nasdaq: ACOM ) , and Cirrus Logic (Nasdaq: CRUS ) plummeting after announcing subpar future guidance, pessimism seems to be taking over in many corporate boardrooms.
- Financial companies like Bank of America (NYSE: BAC ) and Citigroup (NYSE: C ) have come a long way since they hit bottom in early 2009, building profits and succeeding in writing down bad assets. Yet their share prices still teeter on the precipice of potential collapse, as the big drop in shares of the leveraged financial ETF Direxion Daily Financial Bull 3x (NYSE: FAS ) over the past several months shows. Despite assurances that European problems would have minimal impact on U.S. banks, everyone has seemed to be waiting for the next shoe to drop.
All that uncertainty helps explain why the market can move so dramatically in either direction, turning on a dime to retrace its path multiple times. It also serves as a big incentive to keep investors off balance and struggling to figure out the right moves to make in their portfolios.
Turn it around
The fundamental mistake that many investors make is thinking that they have to come up with an overarching investing theme that incorporates everything that's going on every moment. In other words, they assume that the market is always rational, and they adjust their investing strategy to the market's philosophy of the day.
That method only leads to madness. At the lows of the market meltdown, many people thought they were doing the right thing to sell out and abandon stocks entirely. Yet the market's nearly unprecedented recovery showed them just how fleeting the overwhelming pessimism of that period was. Similarly, during bullish periods, the prevailing winds suggest that nothing at all could go wrong -- until something does, at which point panic sets in. Anytime there's a lot of uncertainty, you can't afford to wait for clarity -- because by then, most of the profits will already have been made.
3 pieces of advice
There's a better way to handle choppy markets. First, make sure that you drive your investing decisions, not the market. A strong investing plan will prepare for contingencies and remind you of what to do under certain circumstances. That can be invaluable when emotion threatens to derail your strategy.
Second, take a firm view of what you expect from your stocks and the economy. Your views won't always be correct, but by being resolute about them, you won't find yourself changing your mind every time news drives a stock up or down. That doesn't mean being closed-minded; you need to stay attuned to true changes in a stock's fundamentals. But overall, you should be slow to shift your thinking.
Last, remember that no matter how good you are, you won't always get everything right. But don't let that stop you. Learn from your mistakes, but if you make more good decisions than bad, you'll do fine in the long run.
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