The Fear Index: Building resilience on the market rollercoaster

2nd November 2011

But the anxiety felt from a flutter here or there is different to dealing with the ongoing emotions that daily headlines screaming ‘Greece on the verge of collapse', or ‘Eurozone crisis sparks market turmoil' provoke. In this case, you may feel frozen with fear, wondering – what if my investments disappear? What if I lose and just how much loss can I take?

The rise of ‘super stress'

We are dealing with a time of ‘super stress' to the financial system, with a wide array of commentators predicting gloom and investors' nerves fluttering as the crisis continues to trigger market turbulence.

HSBC's Steven Major told Radio 4 this morning that if Greece can't pay its debts, it would be the biggest-ever default by a sovereign country. That is a "systemic" problem, he said, because those losses would hit banks and cause the whole financial system to slam shut, pulling every other economy down with it, reports the Daily Telegraph.

However, who are we to believe? Alternatively, we have Bob Diamond's of Barclays optimism, who is ‘banking on a quick return to the sort of world that those Pink Floyd rockers sang about in another tune Money – one where you could still "make a stash", say reports. Analysts were quick to congratulate Diamond on the bank's resilience in tough markets, adds the Wall Street Journal.

Putting fear to the test

The "Fear Index", as the Chicago Board Options Exchange Volatility Index (Vix) is popularly known, soared last month, hitting its highest level since the height of the financial crisis in 2008.

The Vix, which is the subject of the latest Robert Harris thriller, The Fear Index, tends to rise when stocks fall. The index measures the cost of options that are bought to insure against equity losses, with a high level indicating how worried investors are about more share price falls.

But typically during a volatile period investors recommend that remaining rational and calm, while focusing on the long term is the wisest stance. Market turmoil and volatility have a strong effect on the psyche of investors, and decision-making becomes dominated by emotional responses, rather than reasoned thinking, leading to – for example – selling stock at precisely the wrong time.

Shaun Richards, Mindful Money's economist blogger, says: "If you're a professional investor you need to keep calm, as the next crisis will be along soon. In essence your intellect and emotions provide a guide, and will be in opposition to each other. So when your intellect tells you the time is right but it feels emotionally wrong and you feel sick and fearful, it is the time to buy – and the reverse is also true, so when there is bombast and euphoria it is often the time to get out. Of course, this isn't the case all the time, but it is a general guide."

The lessons from history

As well as holding nerve, there are buying opportunities – and history tells us that when markets sink, it's the time to invest. For example, let's go back to 2009. Then, the FTSE 100 was as low as 3500, and a plethora of companies in the FTSE 350 were undervalued based on earnings and net asset value, showing all the characteristics of being wise investments – strong cash flow and potential for future growth. However many investors were paralysed by fear because they had seen the stock market collapse from highs of 6700 just 18 months earlier and were unsure of how low the market would fall – so they failed to take opportunities.

Often, investors who can set aside short-term moves will earn a premium for taking risk if they buy rather than sell when markets are low. After all, investing essentially comes down to buying low and selling high.

As an investor, you need to learn the lessons of history. When there is a mass sell-off of assets everything falls – the good assets and the bad. This is a great time to buy quality companies at what could be a bargain-basement price. Shares bounced back strongly after those huge plunges – as they always do over time.

"Invest at the point of maximum pessimism" is a famous quote from legendary investor John Templeton, who was one of the last century's most successful contrarian investors. He scooped up shares during the Great Depression.

Perhaps those who've lived through previous financial crises and recessions have learnt that keeping calm during a storm, and considering timing, is the key to successful investing. These periods leave their mark. In comparison, many of us today have only lived our lives during a period of steady, secure economic growth.

More from Mindful Money:

Greek Referendum: If the bailout goes down, what then?

Market crash: Headlining and tweeting our way to volatility

Market crash: The illusion of knowledge

Market crash: The secret to investment timing

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