The Stock Market’s Dirty Little Secret

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Wall Street took investors on a roller coaster ride on Thursday, as initial pessimism about the stock market’s prospects gave way to a relief rally. By the end of the day, all three major market benchmarks were able to finish in the green, although the Nasdaq Composite (NASDAQINDEX:^IXIC) just barely pushed its way into positive territory. Larger gains of more than a half-percent for the Dow Jones Industrial Average (DJINDICES:^DJI) and S&P 500 (SNPINDEX:^GSPC) reversed what had been even steeper losses earlier in the session.

Index

Percentage Change

Point Change

Dow

+0.62%

+199

S&P 500

+0.52%

+20

Nasdaq Composite

+0.12%

+16

Data source: Yahoo! Finance.

Many investors have had a tough time dealing with the unpredictable volatility in stock market indexes recently. Unfortunately, one secret that investors don’t always grasp is that volatility is simply a fact of life on Wall Street. Professional traders take advantage of those who succumb to emotional responses to that volatility, and so if you’re not prepared to handle the ups and downs of the market, it can end up costing you more than you’d imagine.

The circle of life on Wall Street

Once you’ve been an investor for a little while, you’ll quickly realize that investor sentiment runs in waves. For a while, the entire investment community will seem united in the view that the prospects for the stock market look rosy, with nothing but upside ahead. That can send stocks higher and higher, further driving optimism and creating a virtuous circle of gains for those fortunate enough to experience them.

Then — often suddenly — the narrative will change. Investors will suddenly be reminded that there are potential risks that could bring the long period of gains to a crashing halt. Sometimes, even that threat is enough to cause a significant sell-off in the stock market. At other times, it takes some unexpected event to bring those fears to the breaking point and provoke a correction or bear market.

The key is that Wall Street sentiment can turn on a dime. If you react to every single one of those sentiment shifts, then not only will you end up doing far more trading than you should, but you’ll also find that you’re on the wrong side of most of the trades you make. If you sell after hearing the bad news, you’ll already be getting a lower price for the shares you sell than you would have just days before. And if you wait to buy until the all-clear sounds, those stock prices will already have risen substantially.

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Don’t do what Wall Street pros want you to do

Wall Street wants you to give in to your emotions. That’s a big part of how big financial institutions make money. There are thousands of professionals just waiting to buy your shares low, only to sell them back to you at a higher price a few days, weeks, or months from now.

The best way you can fight back against Wall Street is to keep those emotions in check. For some, it might help to picture the trader who’d happily take the other side of your trade, and visualize that trader’s disappointment that you did the smart thing and stayed the course with your long-term investing plan.

It’s not always easy. When money’s involved, losses hurt.

If you truly believe in the long-term prospects of the investments you own, though, it makes holding on a little easier. That can make the difference between gains over the long run and just another frustrating stock market experience.

Knowing Wall Street’s stock market secret can make you a better investor. Over time, it gets easier and easier — and you’ll end up all the richer in the long run because of it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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