Wednesday, October 1, 2008

Panicked Investors get Whipsawed

After Monday’s big drop in stock prices over the failed vote on the financial bailout, Tuesday saw prices come most of the way back. Apparently, investors as a whole think that lawmakers will find some way to contain the financial problems. The net effect for diversified investors who sat tight through it all is minimal. Those who panicked and sold at the wrong time are facing real losses.

When stock prices fall quickly and then immediately reverse course, it’s called a whipsaw. The same name is used when stock prices rise quickly and suddenly reverse course. The effect is reminiscent of the action of a saw going back and forth cutting through wood.

Such whipsaws generate a lot of concern and discussion, but they really make little difference if you don’t do any trading. Unfortunately, many investors got caught up in the panic and sold their stock holdings near the low point of the whipsaw and plan to “wait until things calm down.”

Unfortunately, these investors have already missed Tuesday’s huge rebound. Prices may yet fall again, but another possibility is that they will continue to drift upward never to return to the levels at the bottom of the whipsaw.

Sadly, many pundits contribute to the panic. Even some who advise sticking to a plan and taking a long-term view are saying that shifting into safer investments is prudent right now. Somehow this sounds different from saying to sell stocks, but it means the same thing.

If you focus on the value of your holdings in say 5 years, stocks are safer to own now than they were at higher prices a year ago. However, the advice from pundits usually runs counter to this obvious fact. They advise caution when prices drop and express confidence when prices are high. This just feeds into our emotions that sometimes cause us to make poor choices in a panic.

I have no idea whether stock prices will rise or fall in the coming days, but as I explained in an earlier essay, nobody else knows what will happen to stock prices in the short term either. What I do know is that you can’t get whipsawed if you don’t sell in a panic.


  1. Great post. A long-term investor is going to encounter sudden, sharp drops in equity prices many times over an investing career. They won't know when or how much but it is almost a sure thing. Panicked selling when it does happen isn't a recipe for investing success.

  2. CC: Thanks. It's so often the case that inaction is the best approach when investing.