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As the Dow Recovers, Smart Investors Can Learn From Rollercoaster Markets

By Dan Caplinger - Dec 18, 2014 at 12:30PM

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Getting wrapped up in the moment is a common investing mistake that can teach you a valuable lesson.

Investors have had to grapple with increasing volatility in the stock market over the past few months as the nearly 6-year-old bull market finally starts to encounter some threats that have ended its long run of almost straight-up gains. Until yesterday afternoon, the abrupt plunge in oil prices and its impact on the economies of resource-dependent nations had spooked many investors into thinking that a correction for the Dow Jones Industrials (^DJI 0.03%) was finally near.

But then the Federal Reserve stepped in with its latest policy statement, and the benign tone that the central bank took in describing its long-term strategy for returning interest rates to more normal levels seemed to give investors the reassurance they needed. After climbing almost 300 points yesterday, the Dow was up another 270 points as of 12:15 p.m. EST Thursday.

Abrupt drops and spikes for the market can be hard even for long-term investors to endure. But you can learn a lot by experiencing these minor episodes of volatility.

Source: Wikimedia Commons. Courtesy Walters Art Museum.

First and foremost, market volatility gives you a better sense of how you actually react to market risk. All too often, investors think they have a certain risk tolerance to market fluctuations, only to discover that they panic much sooner than they would have expected. If you've found yourself following the market's every move and feeling tempted to change your long-term strategy just because of the Dow's recent 5% to 10% moves, then you probably aren't as risk-tolerant as you might have thought.

In addition, volatile markets show that individual stocks don't always behave rationally or in the way that you'd expect in the short run. For instance, much of today's upward move owes to the rising confidence that the decline in energy prices is at or approaching its end. Yet even though energy stocks ExxonMobil (XOM 0.79%) and Chevron (CVX 0.57%) are up with the rest of the Dow's 30 components today, they're among its worst performers. Meanwhile, technology stocks are leading the way higher today, with Microsoft (MSFT -0.23%) up almost 3% despite having little connection either with the situation in the energy industry or with Federal Reserve monetary policy.

Finally, when you step back from short-term volatility, you can see just how little impact most seemingly important news items have in the long run. Consider: In early November, before the decline in oil really picked up steam, the Dow traded at roughly the same level where it is now. Along the way, the Dow has risen as high as 17,900 and fallen below 17,100, but in the end, the volatility has washed out entirely.

Investors tend not to like turbulent markets. But the learning opportunity they provide can be of huge value to you in helping you develop a solid long-term investing strategy that you can follow even during tough times.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$31,261.90 (0.03%) $8.77
Microsoft Corporation Stock Quote
Microsoft Corporation
$252.56 (-0.23%) $0.58
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
$91.86 (0.79%) $0.72
Chevron Corporation Stock Quote
Chevron Corporation
$167.82 (0.57%) $0.96

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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