Why This Stock Market Melt-Up Is So Hard to Handle

Why This Stock Market Melt-Up Is So Hard to Handle

The stock market continued to ascend on Monday, with seemingly no obstacles in sight to keep major market benchmarks from challenging new record highs soon. Hope for help from Washington beat down any worries about the coronavirus pandemic, and high-flying tech stocks led the Nasdaq Composite to another huge gain. Rises for the Dow Jones Industrial Average (DJINDICES: ^DJI) and S&P 500 (SNPINDEX: ^GSPC) were a bit more muted but still added to their recent rallies.

Today’s stock market

Index

Percentage Change

Point Change

Dow

0.88%

251

S&P 500

1.64%

57

Nasdaq Composite

2.56%

296

Data source: Yahoo! Finance.

When the stock market crashes, it’s easy to understand why so many investors get uncomfortable. Yet in many ways, when the market climbs precipitously — as we’ve seen over the past several days — it can be even harder for investors to handle. That might not seem to make sense, and it wouldn’t if everyone followed one simple principle. But market melt-ups reveal the shortcomings of one of the biggest mistakes that many investors make.

Tons of market volatility

We’ve seen huge ups and huge downs throughout 2020, and even though there hasn’t been a market crash the size of what we saw in February and March, it’s still been staggering to see the pace at which market sentiment can turn. Throughout much of the summer, markets gained ground, with many indexes punching through old highs at the beginning of September.

^DJI Chart

^DJI data by YCharts.

That was followed by an abrupt downturn that took most of September. Yet after that correction, markets have moved higher quickly and furiously, with major benchmarks seeing gains of as much as 12% from their lows just a couple of weeks ago. Volatile stocks such as Tesla (NASDAQ: TSLA) have seen even more dramatic moves in their share prices.

Missing out — and the fear of missing out on more

The emotional response to a market crash is obvious: fear. It’s easy to understand why investors can lose their perspective when they’re afraid.

Person at desk with head in hands, looking at stock chart on monitor.

Image source: Getty Images.

The last thing that you’d think investors would have to deal with during a market melt-up is fear. But fear does play a role here:

  • Those who stayed on the sidelines waiting for stocks to get cheaper are suddenly afraid that they’ll never get a chance to invest at all.
  • Those who are fully invested but chose the wrong stocks think that they’ve made bad decisions and second-guess their portfolios.

What’s more, investors who make mistakes during big bull moves feel especially exposed. In a market crash, everyone’s losing money, so it doesn’t feel as bad. But the thought that everyone’s making money except for you — well, that’s a tough one for most people to swallow.

The solution to market melt-ups

Just as market crashes teach investors not to take on more risk than they’re comfortable with, market melt-ups teach investors not to take on less risk than they’re capable of handling. Moreover, just as crashes show the defensive benefits of diversification, melt-ups can reveal that your portfolio doesn’t have enough exposure to the parts of the stock market that are performing the best.

Handling emotions in investing is always a difficult experience. You won’t always get it right. But it’s always worth the effort, because there’s so much at stake that you can’t afford simply to ignore the danger and hope you never fall into the traps that bull market melt-ups pose.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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