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Stock market plunges and soars. Is it acting irrationally?

Swings of hundreds of points up or down have investors wondering if the stock market is irrational. Analysts say the volatility reflects uncertainty about the economy. Get used to it.

By Ron SchererStaff writer / August 11, 2011

A screen displays the final numbers for the Dow Jones Industrial Average on the floor of the New York Stock Exchange, Aug. 11. After dropping nearly 520 points on Wednesday, the stock market soared almost 423 points on Thursday.

Brendan McDermid/Reuters

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New York

One day the stock market loses 500 points in a spate of pessimism. The next day the gloom lifts and the market swings back, rising 500 points.

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The wild swings are enough to make investors wonder if the market is overreacting? Is it irrationally nervous?

On Thursday, investors could legitimately ask those questions as stocks went through another wild day. After dropping nearly 520 points on Wednesday, the Dow Jones Industrial Average soared almost 423 points on Thursday.

Stock market observers say the high level of volatility might well be around for a while. Over the long term, stock prices might begin to reflect the economy and corporate earnings. But, over the next few weeks, fasten your seatbelt.

Peter Coleman, director of research at JMP Securities in San Francisco, says the volatility is in part because of a high level of uncertainty over the future of the economy and the issues surrounding the financial stability of the European banks.

“The market is trading off every bit of information that comes out one way or the other,” says Mr. Coleman, a market watcher for 19 years. “The market is going to continue to be volatile.”

Another reason for volatility, says Pittsburgh investor Andre Weisbrod, CEO of STAAR Financial Advisors, is the stocks of many companies are screaming, “Buy Me,” because their valuations have sunk so low but their balance sheets and earnings prospects appear good.

On Thursday CNBC reported that company executives had increased their purchases of their own companies’ stocks. This is sometimes considered a sign they recognize a good bargain.

But, at the same time, traders looking at charts of the stocks are nervous about buying them. “If you are a technical guy you are looking for signs the market is bottoming here,” says Mr. Weisbrod.

The volatility is also in large part because of a larger amount of angst than normal, says Emma Rasiel, an associate professor of economics at Duke University in Durham, N.C.

“The markets are trading more on psychology,” says Ms. Rasiel, director of Duke’s Financial Education Partnership. “People are scared by what is happening.”

One measure of volatility is the VIX, a futures exchange index, sometimes called “the fear index.” During normal times, it trades at around 20. Recently, it has soared to over 48.

“That means people are panicking,” says Rasiel, referring to the price level on the VIX.

Another measure of volatility is the large spread between the highs and lows for the trading session. In August, there have been six days where the high separated the low for the day by more than 400 points. In the two years between July 2009 and July 2011, there were three such days.

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