How to deal with a volatile market

Just look at the Dow Jones industrial average, will you? It’s been whipping up and down a lot lately. On one recent day, it was up 417 points, or 3.6 percent – its strongest one-day gain since 2003. Not much earlier, it had fallen 370 points, or 2.9 percent. It’s enough to give you whiplash.

It’s also enough to cause investors to make mistakes. Don’t let yourself become one of them. Keep the following thoughts in mind:

First off, know that “the Dow” is an average that represents just 30 companies out of many thousands on the American markets. For a better representation of our stock market, look at the movement of the S&P 500 (500 of America’s biggest firms) or the Dow Jones Wilshire 5000, which represents the “total stock market” and encompasses more than 5,000 companies.

Next, remember that a falling market isn’t necessarily bad. It can present great opportunities, as stock in many great companies is suddenly on sale. If you’re 20 years away from retirement, for example, how much does it really matter that your holdings fell 2 percent this week? What really matters is where they are in 20 years, or whenever you want to sell them. The prices at which you buy and sell are the only ones that give you a profit or loss. As superinvestor Warren Buffett has explained, if you’re going to be buying more shares of stocks in the coming years, you should be happy to see falling prices.

Money you expect to need in the coming few years, though, should not be in stocks, where anything can happen in the short term. (Learn how to invest short-term money at www.fool.com/savings.)

Investors err when they succumb to fear or greed. They buy or hold on to overvalued stocks out of greed, and they sell in a panic when stocks fall. Don’t do that. Expect healthy stocks to fall sometimes and to recover, eventually. The stock market may be volatile, but over long periods, its trend has been up.

Q: Would I be smart to look for stocks that are trading near their 52-week lows and to consider selling ones trading near their highs? – G.J., Murfreesboro, Tenn.

A: Never focus on just a stock’s price. If a company’s stock is trading near its all-year low, that might be due to some temporary or long-lasting trouble. Further research can help you decide whether you think it will recover well enough to make it a promising investment, or whether it’s a doomed enterprise.

Q: How does stock get diluted? – B.U., Walnut Creek, Calif.

A: Stock dilution happens when a company issues additional shares of its stock, decreasing the value of existing ones. Imagine that you own one of a pizza’s eight slices. If it’s cut into 10 pieces instead, you’ll own a tenth instead of an eighth. Your ownership share has shrunk.

My dumbest investments

Back in 1998, I bought 1,000 shares of Green Mountain Coffee Roasters for about $4 per share. I was all about short-term gains back then, and I was ecstatic when two years later I sold for a little over $10 apiece. If I hadn’t sold, I’d be sitting on 6,000 shares (due to stock splits) priced around $28 per share and with what I consider to be the company’s brightest days still ahead. Becoming a Fool has taught me to slow down, look toward a more distant horizon and have some faith in companies with solid fundamentals. But I’m still kicking myself about this one. – N.A., via e-mail

The Fool Responds: One of the most common mistakes that investors make is selling a solid holding too soon. Green Mountain Coffee Roasters shares have risen more than 25-fold over the past decade, enough to turn a $5,000 investment into more than $125,000. Only five months after the shares hit $10, they hit $20. The biggest bucks are often made by sitting on your hands, for years.