Risk exists because the value of stocks and other assets change — sometimes constantly throughout the day. Prices drop, but they also rise. All that change is called market volatility.
“Volatility” may sound bad, but it really just describes changes in the market. A rising market where prices go up in value indicates a change, but most investors would agree it’s a positive one instead of a negative.
We know that at times, the stock market will rise in value. And we also know there will be times it will drop. Because the ultimate goal is to make money when you sell your assets on the market, the ideal way to invest is selling for more than you bought.
This is also where average investors get into a lot of trouble. Most people simply aren’t good at timing the market, or knowing when stock prices will rise and fall.
As a result, average investors tend to buy high and sell low, because they fail to time the market well. They hear about a stock that’s seeming to gain momentum in the market and buy in after the price has already increased dramatically. Or after seeing an asset lose a significant amount of value, they sell, hoping to exit before the bottom, only to see the asset eventually rebound. Essentially, they spend a lot of money to buy expensive stock and risk losing that money because they tend to sell when values are low.
Sounds counterintuitive, right? It happens because when stock prices are high, people’s confidence is also high. We feel good about the market and where it’s headed — and we want to buy in when things are going well.
When stock prices drop, people tend to panic. They want out of what they feel is a bad situation that’s only going to get worse. Panic can trigger a selloff, where people are simply trying to dump their stocks to get out of them.
This isn’t rational. Remember, due to market volatility, stock prices will drop and they will rise. Historically, the stock market has increased in average value. In the 10-year period between 2007 and 2016, for example, the S&P 500, one measure of the overall market’s performance, increased by about 30% despite one of the country’s worst ever recessions. Holding stocks for the long term — even through down periods — is typically a better play than trying to time the peaks and falls of the market.
There is a famous saying: You need to be fearful when others are greedy, and greedy when others are fearful. When other investors are snapping up stocks, demand is high — and so are prices.
Conversely, when other investors get scared and start disposing of stock as quickly as they can, demand drops. This creates an opportunity to buy stock at lower prices and to make money on your investment if you can hold the asset long enough for the value to rise again.