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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.

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Rasiel says a major reason for the overreaction by the markets is sharp losses many people have experienced in their portfolios. According to Moody’s Analytics, the stock market has lost $3 trillion in value since the peak in late April.

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The losses are resulting in emotional decisions. Rasiel says “behavioral economics” has found the extent to which people hurt from losses is twice the enjoyment they get from gains. “So, there is some major misery going on here,” she says.

At the same time, Coleman says the wide swings are partly the result of the cloudy economic situation.

“The reality is that the data is continuing to show the economy has not grown as much as anticipated and is even slowing in some respects,” he says. “This increases the loud noises we are hearing from people who think we will see a double dip.”

Coleman thinks the markets will stabilize once it becomes clearer which direction the economy is going.

On Thursday, for example, new claims for unemployment came in lower than expected. This led some investors to wonder if the economy might not be as weak as anticipated. More information will come out on Friday when the Commerce Department reports on advance monthly (July) retail sales.

“One positive is that we know the Federal Reserve over the next few years will keep rates low,” he says. But, he adds, this also means that the Fed expects the economy to have weaker growth than expected. “The Fed is sending a signal – we’re worried about the economy too,” says Coleman.

In a recent article on Yahoo! Sports, reporter Eric Adelson writes that Mark Cuban, the owner of the Dallas Mavericks, blames computerized trading for the volatility. After the May 6, “flash crash” where the Dow fell 1,000 points in minutes because of computerized trading, Mr. Cuban wrote, “There will be another crash.”

There might be something to this, says Rasiel, since many of the computer programs use the same triggers for their trading. “It should not have an effect, but if you think about it, and if they all use the same triggers, it becomes like a self-fulfilling prophecy,” she says.

Monitor Intern Geoff Johnson in Boston contributed to this story.

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