If you are turn on any of the up-to-the-minute financial news programming, you’d hear the anchors yelping about what stocks are up, which stocks are down, and all of the reasons why.
Every day, someone compares the stock market to a rollercoaster ride, with its ups, downs, and sideways action; sometimes enough to make you want to lose your lunch.
The stock market has become something of an affair in entertainment. If the stock market is down, it’s entertainment. If the stock market is up, it’s entertainment. But, it’s also people’s lives and livelihoods.
There are millions of people who have their retirement savings tied up in the stock market. For these people, fluctuations aren’t fun or interesting, they can be painful. A great way to overcome the pains associated with stock market fluctuation? Understand why it’s happening. We all know that some amount of stock fluctuation is normal. But just how much?
Below, we will first answer the question, “Why does the stock market fluctuate?” in order to understand how much market fluctuation is normal. Having a good grasp on volatility in the stock market is critical to as an investor in the stock market over your lifetime.
Why Does the Stock Market Fluctuate?
To understand market fluctuation, it helps to first understand stocks and the stock market.
A stock, which is a small percentage of ownership in a company, can be bought and sold by investors like us. That’s right, everyday folks can own a share of companies like Tesla, Starbucks, and Snapchat. That’s why investors of stocks are also called shareholders.
A stock might be bought and sold in what we call the stock market. And the stock market is like any other open marketplace; it just so happens that what’s for sale are these pieces of ownership in a company, called shares. And just as in any open marketplace, there are two important forces that determine the value (and therefore the price) of these goods for sale: supply and demand.
Remember our old friends, supply and demand? Let’s do a refresher, because they’ll be important later. Supply is how much of a good is available for sale. Demand is how much consumers want to buy the good. Between the pressures of supply and demand, the economy determines the value of that good.
Here’s an alternate way to describe supply and demand: buying and selling. How much investors are buying or selling a certain stock on any given day, month, or year, quite literally give a stock its value.
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Crazy, right? So while the television commentators may have you believe that it’s some single, external event (such as a tsunami or newly released economic numbers) that causes the price of stocks to increase or decrease, that’s not totally true.
The real truth is that investors were selling out of their stocks in a way that outpaced how many investors were buying into those same stocks; supply and demand at work. Why does the overall stock market fluctuate? Because investors are buying and selling stocks in such a way, and in such volume, that stock prices make a large move in one direction or another. That’s it.
Volatility Means the Stock Market Is Working
As tough as a nasty price drop in your investments can be to stomach, stock market volatility is a normal part of stock market investing. In fact, volatility is natural and even healthy, and shows that the stock market is working as it should. If you want to be a good stock market investor, you have to accept this.
Here’s why: The more investors weigh in—by actively buying and selling stocks—the more accurate the prices of stocks will ultimately be. Think of it this way: If you needed an opinion about something that didn’t have a precise answer (in this case, what the value of any one stock should be), would you ask just one person? Two people?
Or would you take a poll from as many people as possible, weighing out all of their many respective perspectives and responses? That’s essentially what is happening in the stock market—it’s a weighing of information about the “correct” price of a stock from investors across the globe.
It’s also helpful to remember that volatility doesn’t just relate to rising stock prices—it also relates to plummeting stock prices Yet for whatever reason, some only really think about “volatility” and “stock market fluctuation” as happening when there’s a downturn in the market. But when the stock market makes a surge upward, that is also considered stock market fluctuation too.
If you want the possibility of returns, you have to be willing to see your investments dip sometimes. Risk and reward are two sides to the same coin. You cannot have one without the other. If you hear someone promising outsized returns with no risk, it is absolutely a scam; run far, far away.
The stock market has returned about 10% annualized over the long term according to some estimates . But almost never does this come in the form of perfectly 10% years. Usually stock market returns are higher or lower than this, and they sometimes even go into the negative.
So, What is Normal?
This is a notoriously hard question to answer because really, almost any amount of market fluctuation is possible.
Of course, this would be hard to believe if all of your stock investments were down 50% or more. But such drops have happened in the past, and could happen again.
Our best guide for understanding what is normal (and what is abnormal) is to look at what has happened in the past. While past performance is never a guarantee of future financial success, it’s helpful to look at the data.
The most commonly cited pool of data is the S&P 500, which is an index that measures the returns of the United States’ 500 “leading” U.S. companies. The S&P 500 can give us a good historical gauge of stock market movement.
Since World War II—the “modern” stock market era, the S&P 500 has seen 11 drops in the stock market of over 20% . A more than negative 20% market is what is classified as a “bear market,” or a bad market.
|May 29, 1946||-30%|
|August 2, 1956||-22%|
|December 12, 1961||-28%|
|February 9, 1966||-22%|
|November 29, 1968||-36%|
|January 11, 1973||-48%|
|November 28, 1980||-27%|
|January 11, 1973||-48%|
|November 28, 1980||-27%|
|August 25, 1987||-34%|
|July 16, 1990||-20%|
|March 27, 2000||-49%|
|October 9, 2007||-57%|
You’ll notice that a big drop in the stock market happens about once every five to ten years—so somewhat frequently. And smaller fluctuations of 5% or 10% to the downside happen much more frequently than that. In fact, it’s common to see a drop like this in most years.
As far as we’ve seen, there has never been a market dip that hasn’t eventually recovered. And really, it seems like the most upward movements happen after the worst of times. While there’s no denying that seeing a big drop in the value of your investments is painful, it’s possible to learn from the bad times. It is important to understand that dips are normal, and that shouldn’t necessarily scare you from investing in the market.
Also, know thyself. Investing in good times is easy. Investing in bad times is hard. If you’re skittish or uncomfortable with market gyrations, you may want to consider having an financial advisor on hand who can help talk you through any confusion.
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