Buying low and selling high is a great way to make money in the stock market. But there’s a rub: It is impossible to know whether you are reaching a low or a high. The S&P 500 fell 4.5% between Monday and Thursday this week, before stabilizing today (Oct. 12). Could it be the start of a crash, or major correction, and is it time to sell? Or maybe stocks are cheap and it’s time to buy?
It seems like a lifetime ago, but the market also dropped in February, with the S&P 500 falling 10%. People got spooked, fearing it was the end of the bull market. But even at its lowest end-of-day point, the market was about 7% higher this week than its February lows. Selling at the bottom then would have meant missing out on months of positive returns.
It is impossible to know what will happen next. Maybe today’s stabilization and slight recovery was a dead-cat bounce and there will be bigger drops in the near future. Or perhaps markets will climb 20% or 70% in the coming months or years.
Many people have jobs that try to make sense of it (paywall). They’ll tell you this was the week investors who chase risk factors changed strategies, for reasons we don’t know. Others believe that for three days this week people started to care about rising long-term interest rates. Others blame the Fed because they think the purpose of monetary policy is to prop up stock prices (it isn’t). All of these stories made lots of sense on Thursday. Bloomberg columnist Barry Ritholtz reminds us that hindsight bias means everyone can call the market. But then what can explain the rebound today? Maybe all we know is volatility is back and stocks are risky and impossible to predict.
There are reasons to fear this is just the beginning and stocks will fall further. The bull market is nearly a decade old. It keeps rising despite the threat of trade wars, unstable politics, and low productivity. But the odds are good (though not guaranteed) that stocks will return more than safer assets do over the next few decades. This is our reward for taking on the ever-present risk of stock prices falling. If you fear a drop in prices because you’ll need your money soon, or you just can’t handle loss, stock investing may not be for you, and you should decrease your holdings.
There is no shame in risk aversion.