Stock shock: Markets go up as well as down

As the great stock market recovery continues, The Motley Fool looks at what you must do to be a truly successful investor.

It was only a few weeks ago when global share markets were tanking.

The economic news was terrible. Depending on what you read, or who you listened to, European banks were about to collapse en-masse and the U.S. was about to plunge into recession…again.

Naturally, unable to stand on its own two feet, the Australian stock market, and indeed its economy, followed the rest of the world down, down and down.

At one stage in August, the S&P/ASX 200 index had plunged 24% from mid April, a full-blown crash in anyone's language.

There was simply nowhere to hide…

Source: Capital IQ, a division of Standard & Poor's

So bad were things that in mid August The Australian Financial Review's weekend edition lead with the story "Is the market just too dangerous for average investors?"

Fear, uncertainty and panic ruled.

Less bad

Fast forward to now. Yesterday, following a strong lead on Wall Street, the Australian market jumped 1.5%.

Overnight, U.S. markets continued their recovery, buoyed by optimism the world's biggest economy will not fall into recession, Hurricane Irene wasn't as destructive as was feared, and Greek stocks jumping the most in more than 20 years.

Relief is the word.

Even famed investor Mark Mobius piled on top, saying on Bloomberg the U.S. economy is "not going to see a recession." No ifs, no buts there…

This is why we sell

So why the great panic of just a few weeks ago?

Fear is a very strong emotion. In the face of extreme danger, our in-built survival mechanism kicks in. We take refuge and head for safety.

For investors, safety means selling shares and depositing the proceeds in the bank account. When everyone sells at once, and no-one buys shares, the market can only go in one direction. The result is a classic, cyclical, recurring stock market correction.

Cosy

Banks are a warm and cuddly place for our money. We earn a little interest, and more importantly, our bank balance doesn't fluctuate. Away from the extreme volatility of the share market, we can breathe a large sigh of relief.

But safety comes at a huge cost. Fearful investors sell when stocks are trading at discount prices, regardless of the underlying value of those individual stocks.

Making matters worse, often these same investors have been happy to buy these shares at considerably higher prices, lured into the market when the going seemed good.

Fantasy-investing

People who think they can consistently time the market – buy at the bottom and sell at the top – are living in fantasyland. Instead, investors should simply commit to investing in the market over an extended period of time.

The Motley Fool has always espoused that you should only invest in stocks using money you won't need for at least three years, and ideally five or more.

Inviting stress

In other words, don't invest in the stock market with the money you need for the mortgage next month, your child's tuition in a few years, or a vacation to Europe in 2013. If you do, you're just inviting stress — and unavoidable losses — if stocks go down.

To be a successful investor, you must resolve to keep buying and holding good businesses when others are selling.

This period of market volatility may yet have a sting in the tail. The VIX index, otherwise known as the fear index, still trades at 32, some way above its long-term average of around 20.

As with life, the future remains uncertain. But despite all the ups and downs, we believe stocks will remain one of the strongest possible ways to grow your assets in the years ahead.

To help investors navigate their way through these volatile times, The Motley Fool has produced a special free report titled Read This Before The Market Crashes. Simply click here to request your complimentary copy.

As ever, we wish you happy investing.

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