This Is Falling, With Style

In psychology, basophobia (the fear of falling) is often more visceral than acrophobia (the fear of heights). Why? Because falling hurts. But in the markets, these drops aren't free-falls; they’re bungee jumps. Last week, we saw the stock market fall from its all-time high, reaching a 10% drop from its peak, the limit known across Wall Street as a Correction. This week, we saw the market move up 6% by the close on Wednesday. These swings may seem scary, but don’t let them shake you. They’re actually quite normal and the market always recovers.

History shows us that 5%, 10%, and even 20% market drops are a frequent event:

The chart above shows that since 1928, the market has fallen 10% or more 56 times. That’s 56 times in 98 years. Last week was #57. 23 of those 56 times, it fell 30% or more at some point in the year. During those selloffs, it has taken the market 6.5 months on average to bounce back and return to the old highs. These drops aren’t free-falls, they’re bungee jumps.  

So, should you think about buying the dip when the market falls? It all depends. Like when a jumper bungees off their platform and bounce back up, there’s an initial snap back in the stock market before it may travel back down. These snapbacks are often the result of a Short Squeeze. A short squeeze occurs when a sharp rise in price forces 'short sellers' to buy shares back at a loss just to exit their positions. Because this rally is fueled by traders forced to buy rather than investors choosing to hold, the rally often fades, leading to the infamous 'Dead Cat Bounce’ pattern. On Wall Street, this is called a Dead Cat Bounce because even a dead cat will bounce if it falls from a high enough distance (I promise I didn’t make that up).

But the markets don’t fall forever. Eventually, the market finds a ‘floor,’ the level where people step in to buy and hold stocks. The market doesn't find a floor by accident. It finds it when the potential return becomes too attractive to ignore. Once the market goes back above key technical levels—like the 50-day or 200-day moving averages—the bungee jump is over, the jumper and the equipment return to the platform (the stock price from where the fall started), and the stock market can resume going higher.

Don't fear the fall. Buy the fall.