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Riskier long-term saving requires that an individual possess the ability to manage the associated increased risks. Stock prices fluctuate widely, in marked contrast to the stability of (government insured) bank deposits or bonds. This is something that could affect not only the individual investor or household, but also the economy on a large scale. The following deals with some of the risks of the financial sector in general and the stock market in particular. This is certainly more important now that so many newcomers have entered the stock market, or have acquired other 'risky' investments (such as 'investment' property, i.e., real estate and collectables).

With each passing year, the noise level in the stock market rises. Television commentators, financial writers, analysts, and market strategists are all overtalking each other to get investors' attention. At the same time, individual investors, immersed in chat rooms and message boards, are exchanging questionable and often misleading tips. Yet, despite all this available information, investors find it increasingly difficult to profit. Stock prices skyrocket with little reason, then plummet just as quickly, and people who have turned to investing for their children's education and their own retirement become frightened. Sometimes there appears to be no rhyme or reason to the market, only folly.

This is a quote from the preface to a published biography about the well-known and long term value oriented stock investor Warren Buffett. Buffett began his career with only 100 U.S. dollars and has over the years built himself a multibillion-dollar fortune. The quote illustrates some of what has been happening in the stock market during the end of the 20th century and the beginning of the 21st.

Facts affecting Stock Prices

From experience we know that investors may temporarily pull financial prices away from their long term trend level. Over-reactions may occur— so that excessive optimism (euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly low. New theoretical and empirical arguments have been put forward against the notion that financial markets are efficient.

According to the efficient market hypothesis (EMH), only changes in fundamental factors, such as profits or dividends, ought to affect share prices. (But this largely theoretic academic viewpoint also predicts that little or no trading should take place— contrary to fact— since prices are already at or near equilibrium, having priced in all public knowledge.) But the efficient-market hypothesis is sorely tested by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percent — the largest-ever one-day fall in the United States. This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a definite cause: a thorough search failed to detect any specific or unexpected development that might account for the crash. It also seems to be the case more generally that many price movements are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period confirms this. Moreover, while the EMH predicts that all price movement (in the absence of change in fundamental information) is random (i.e., non-trending), many studies have shown a marked tendency for the stock market to trend over time periods of weeks or longer.

Various explanations for large price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact.

Other research has shown that psychological factors may result in exaggerated stock price movements. Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes in clouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor's self-confidence, reducing his (psychological) risk threshold.

Another phenomenon— also from psychology— that works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group.

In one paper the authors draw an analogy with gambling. In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically.

The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the recent NASDAQ crash, less than 1 per cent of the analyst's recommendations had been to sell (and even during the 2000 - 2002 crash, the average did not rise above 5%). The media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so-called new economy stock market. (And later amplified the gloom which descended during the 2000 - 2002 crash, so that by summer of 2002, predictions of a DOW average below 5000 were quite common.)

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  • INTRADAY CHART
    DOW
    NASDAQ
    S&P
    NAME LAST CHANGE % CHANGE
    DOW 16,408.54 -16.31 -0.10%
    NASDAQ 4,095.52 +9.29 +0.23%
    S&P 1,864.85 +2.54 +0.14%
    10-Yr Note 100.24 unch unch
    • Market index data delayed by 15 minutes.
    VIDEO ON MSN MONEY
    MARKET UPDATE
    [BRIEFING.COM] The stock market ended the holiday-shortened week on a mixed note as the Dow Jones Industrial Average shed 0.1%, while the S&P 500 added 0.1% with seven sectors posting gains. Equity indices faced an uphill climb from the opening bell after disappointing quarterly results from Google (GOOG 536.10, -20.44) and IBM (IBM 190.04, -6.36) weighed on the early sentiment. Google reported earnings $0.15 below the Capital IQ consensus estimate on revenue of $15.42 billion (expected $15.52), while IBM revealed in-line earnings on revenue that was roughly $500 million below expectations. The results from the two pressured the technology sector (-0.3%), which was down as much as 1.0% durin ... More
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    ADVANCERS & DECLINERS
    NAME NASDAQ NYSE
    Advancers 1,663.00 1,814.00
    Declines 955.00 1,306.00
    Unchanged 81.00 91.00
    Advancers to Decliners 1.74 1.39
    Advancing Vol 1.08 Bil 2.04 Bil
    Declining Vol 732.41 Mil 1.26 Bil
    Unchanged Vol 28.76 Mil 44.59 Mil
    Total Vol 1.85 Bil 3.34 Bil
    TRENDS
    GAINERS
    SYMBOL NAME VOL LAST CHANGE % CHANGE
    SHLD SEARS HOLDING CORPORATION 3.63 Mil 38.33 +4.73 +14.08%
    NNI NELNET Inc CLASS A 238,779 43.64 +4.33 +11.02%
    SNDK SANDISK CORP 12.32 Mil 82.99 +7.14 +9.41%
    MBT MOBILE TELESYSTEMS OJSC 6.66 Mil 17.10 +1.35 +8.57%
    VIP VIMPELCOM Ltd 7.61 Mil 9.00 +0.71 +8.56%
    PLXS PLEXUS CORP 638,422 43.52 +3.24 +8.04%
    QIWI QIWI PLC 878,684 34.01 +2.24 +7.05%
    CSLT CASTLIGHT HEALTH Inc 846,106 19.85 +1.30 +7.01%
    WSO/B WATSCO Inc CLASS B 3,901 104.52 +6.75 +6.90%
    SINA SINA CORP 12.7 Mil 56.55 +3.56 +6.72%
    LOSERS
    SYMBOL NAME VOL LAST CHANGE % CHANGE
    CHMT CHEMTURA CORPORATION 6.01 Mil 23.16 -2.05 -8.13%
    ADS ALLIANCE DATA SYSTEMS 2.12 Mil 245.06 -19.01 -7.20%
    CMG CHIPOTLE MEXICAN GRILL Inc 3.88 Mil 519.61 -32.79 -5.94%
    RARE ULTRAGENYX PHARMACEUTICAL Inc 410,142 42.56 -2.66 -5.88%
    EJ E-HOUSE(CHINA) HOLDINGS LIMITED 2.5 Mil 10.44 -0.55 -5.00%
    CNS COHEN & STEERS Inc 218,514 39.79 -2.09 -4.99%
    WU THE WESTERN UNION COMPANY 19.58 Mil 15.25 -0.80 -4.98%
    STLD STEEL DYNAMICS INC 7.95 Mil 18.00 -0.90 -4.76%
    FCS FAIRCHILD SEMICONDUCTOR INTERNATIONAL Inc 3.93 Mil 12.90 -0.62 -4.59%
    SWC STILLWATER MINING COMPANY 5.59 Mil 15.50 -0.68 -4.20%
    MOST ACTIVE
    SYMBOL NAME VOL LAST CHANGE % CHANGE
    BAC BANK OF AMERICA Corp 104.77 Mil 16.15 +0.02 +0.12%
    FB FACEBOOK Inc CLASS A 88.04 Mil 58.94 -0.78 -1.31%
    GE GENERAL ELECTRIC 69.66 Mil 26.56 +0.44 +1.68%
    CSCO CISCO SYSTEMS INC 47.81 Mil 23.21 +0.18 +0.78%
    MU MICRON TECHNOLOGY Inc 46.21 Mil 23.91 +1.43 +6.36%
    AA ALCOA INC 40.97 Mil 13.56 +0.14 +1.04%
    ZNGA ZYNGA Inc CL A COMMON 39.18 Mil 4.29 +0.18 +4.36%
    INTC INTEL CORP 38.11 Mil 27.04 +0.11 +0.41%
    MSFT MICROSOFT CORP 36.69 Mil 40.01 -0.39 -0.97%
    SIRI SIRIUS XM HOLDINGS INC 34.44 Mil 3.14 -0.03 -0.95%
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    WORLD MARKETS
    NAME LAST CHANGE % CHANGE
    Nikkei 225 14,516.27 +98.74 +0.68%
    FTSE 100 6,625.25 +41.08 +0.62%
    DAX 9,409.71 +91.89 +0.99%
    TSX 14,500.39 +53.87 +0.37%
    COMMODITIES
    NAME LAST CHANGE % CHANGE
    Gold 1,293.80 -9.30 -0.71%
    Silver 19.65 +0.02 +0.08%
    Light Sweet Crude Oil 104.59 +0.83 +0.80%
    CURRENCIES
    SYMBOL RATE CHANGE % CHANGE
    EUR/USD 1.38150 +0.00010 +0.01%
    USD/JPY 102.39500 +0.01500 +0.01%
    GBP/USD 1.67935 +0.00015 +0.01%
    USD/CAD 1.10239 +0.00169 +0.15%
    USD/CNY 6.21910 +0.01000 +0.16%
    TREASURYS
    NAME LAST CHANGE % CHANGE
    3-Mo Bill 0.03 unch unch
    5-Yr Note 99.49 unch unch
    10-Yr Note 100.24 unch unch


     
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