Rules of the Game: Avoid Volatility Panic

 | Nov 11, 2013 | 2:00 PM EST
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I want to continue with my previous theme of volatility.

Many investors, with active encouragement from financial TV and magazines, get spooked by day-to-day price swings in the major indexes and in single stocks.

But these short-term price movements have zero, zip, and zilch, nada to do with your investment philosophy and risk tolerance.

People are quick to say it has everything to do with risk tolerance, but that's one of those nice little lies we tell ourselves. Intra- and inter-day price swings are what longer-term trends are made of.  But with media driven by page views, subscription sales and ratings, it's not in their best interest to tell you, "Calm down, markets are operating efficiently, the way they always have." (And yes, 2008 was an example of market efficiency. But the media didn't explain that, did they? Why would they?)

Your risk tolerance shouldn't be how much you sweat watching First Energy (FE) decline in the premarket. Really? This is what it's come to?

No, risk tolerance is tied to how much income you need in your non-working years.

That's a tough concept for many to grasp, and I understand that. But it's only tough because we are societally conditioned to focus on the minutiae, rather than on our own personal situations. Market movements are fun and exciting, and it's a thrill to identify a great long or short candidate and have a winner on your hands.

I know many people from my trading days that scored gains with this stock or that one. Big deal. It may have been a little fun money in their account, but it didn't affect their longer-term income stream much, if at all.

I get hate mail from telling people that they can't "beat the market" (whatever that means) long term. It's like driving: Everybody thinks they are an above-average driver, but that can't be true. All stock traders think they have it in them to "make money," beat some index or some other nebulous benchmark. How can that be? If you get the right program, study hard enough and use the right oscillators in the right combinations? Sure, if you say so.

I have to be blunt: People skew the truth when it comes to reporting their own trading results. Sometimes it's unknowingly. At a seminar I did recently, a guy was insisting that his cohorts in some trading meet-up were consistently beating the market. Well, if you use instruments that have higher volatility than the S&P, then yes, you can beat the S&P for some period of time. Doesn't mean it's the right benchmark to use, though.

And who really knows how those "true" results are put together? I, for one, don't put much credence into self-reported eye-popping returns, other than some anecdotal stroke of luck here and there.

I digressed quite a bit, but it all ties back to the notion of volatility and risk tolerance. You have to have some idea of your risk tolerance beyond the breathless tick-by-tick reporting of some TV anchors.

Take a look at your investment philosophy. Does it jibe with your financial plan, for how much income you need and for how long? Investing should be done for one reason: To meet future liabilities. Doesn't that already feel calmer than being in panic mode, watching every little market movement?

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