How to respond to market 'dips'
By Brad O'Neil
You already know stock prices can take sudden "dips," but do you know what causes them?
And, as importantly, is there any way you can take advantage of those drops?
Let's answer the questions one by one. First, what causes the stock market to fall quickly?
Actually, the "suddenness" of a market decline may often be misleading, because the forces that cause markets to fall (or rise) may be in place for weeks or months before prices move noticeably. Here are some of these key "change agents."
• Investors' actions - Individual and institutional investors can, by their actions, move the price of stocks.
For example, if many people think a particular stock is "hot," they will buy it, and the increased demand helps drive up price.
Conversely, if investors decide a company is in trouble or it's part of an industry in decline, or even that it's time to take profits, they will sell stock, creating downward pressure on its price.
• Business fundamentals - A company earnings, profit margins, management and competitiveness can affect its desirability to investors and, as a result, its stock price.
• Legal changes and regulatory decisions - When Congress passes a law or a government regulatory agency makes an important decision, the result can have a big effect on the fortunes of a company - and, consequently its stock price.
Decisions by the Federal Reserve to change interest rates also can affect the financial markets and individual stock prices.
• Economic indicators - When economic activity - as measured by the gross national product - slows, unemployment increases and inflation rises, investors may get nervous and pull back from the markets, leading to a drop in stock prices.
• International events - Political instability, wars, natural disasters and similar events can all disrupt financial markets and cause stock prices to fall.
It's very hard for most people to follow these events closely enough, and respond to them quickly enough to take advantage of market drops by buying stocks whose price has fallen.
Furthermore, although it would be great to always "buy low and sell high," it's impossible to predict when a stock has fallen to its lowest point. Consequently, you could end up wasting a lot of time, energy and worry by trying to "buy on the dip."
If you were to constantly buy stocks just because the price had dropped, you may well end up owning a lot of investments that aren't really suitable for your individual needs, goals, risk tolerance and time horizon.
You would be better off purchasing an appropriate mix of quality investments, holding them for the long term and making adjustments only when your situation changes or when the investments themselves have altered in a way that's not positive for you.
Ultimately, it's a good idea to stay informed about the various forces that affect stock prices. The more you know, the less surprised you'll be when the market goes up or down.
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