How to Deal with Randomness in the Stock Market - dummies

How to Deal with Randomness in the Stock Market

Technical traders acknowledge that random events can and do cause a stock to have an occasional wild price departure from the norm, but the acknowledgement doesn’t alter the expectation that prices will behave normally. For example, you sometimes see a price spike so big that you don’t know how to interpret it. Often, you never find out why such a bizarre price occurred.

A price spike is the equivalent of a tornado in weather forecasting. You know the conditions that cause tornadoes — you just don’t know exactly when an actual tornado will develop.

Although nature may not be able to deliver a tornado in Alaska in January, the equivalent does happen in markets. Most market tornadoes, like Black Monday in 1987 (when the S&P 500 fell more than 20 percent in a single day), give plenty of technical warnings ahead of time. The problem is that traders often have those same warnings and don’t get a Black Monday. This is an inconvenient fact of life that you have to accept.

Spikes are both a problem and an opportunity:

  • If you know why a spike is occurring because you’re well informed about world events and market chatter in response to the world events, you may chose to ride it out.

  • To exit on fear of randomness is okay, too. You take no risk when you are out of the market. Nowhere is it written that you must have a position in the market at all times.