Wealth through conventional investment principles

Stock market behaviour

Stock market behaviour

Stock markets have gained the reputation for being very volatile environments and places where many people have lost a great deal of money. And yes, many people have indeed lost lots of money on the stock markets. The other truth is that many people have made lots of money on the stock markets and in the process became very wealthy.

One only have to look at the price graph of either a share or a market index to see large changes in prices, either up or down. Prices are in constant motion and changes by the minute, day, and month and over years. These changes in price can be relatively small and at times very large. An extreme example known to many share investors was when the Dow Jones in 1987 lost more than 22% in one day – nowadays known as Black Monday.

It is therefore true that the stock markets are very volatile environments and that it will from time to time correct sharply and even crash.

Statistics indicate that markets are likely to experience sharp corrections of up to 10% on average once a year. A 20% correction can be expected every three to five years, while a 30% to 40% correction “crash” happens on average about once in a decade.

This is the nature of the stock markets, it is nothing new and every investor will experience and live through these corrections from time to time. Would be investors have to accept this fact, make peace with it and plan their actions on the investment markets accordingly.

The key to successful investing lies in the following:

  • Recognise the markets as highly volatile and unpredictable environments and approach the markets accordingly.
  • Make a careful study of the markets and try to understand what cause prices to change, why the markets correct from time and will at times even crash.
  • Recognise the fact that bull phases (periods of rising share prices) are on average much longer that bear phases (periods during which prices decreases). The markets are therefore in growth phases for more of the time than in declining phases.
  • Recognise that the long-term price trend is upwards and that a long time horizon is required for successful investing.

Despite its volatile and unpredictable nature, the stock market remains the best inflation beating asset class and people with a long time horizon can and will be very successful and realize wealth growth that far exceeds the rate of inflation.

Most important of all, investors have to manage their investment risks. There are many approaches and strategies to contain and manage investment risks down to acceptable levels to protect one’s capital from permanent loss and to achieve real wealth creation.

Risk and risk management are vital to successful investing and are discussed in detail elsewhere on this website.

“I am quite confident that the markets are reasonably rational over longer periods, but I am equally confident that that they can be completely irrational over shorter time frames”

Warren Buffet