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The good times can’t last forever. After the stock market was on a tear in 2017, it now appears that “volatility” lies ahead. USA TODAY

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Wall Street hit the pause button Tuesday on a panic that had sent the Dow spiraling down more than 1,800 points over the two prior days, enabling the Dow to close 567 points higher.

It was a wild day of swings for the Dow Jones Industrial Average, which rallied back from an early plunge of more than 500 points. Overall, the Dow, which finished 2.3% higher at 24,912.77, swung 1,167 points from its low to its high.

Stocks appeared to stabilize by the end of Tuesday after the blue chip average's biggest drop in history a day earlier had sent anxiety through global markets. 

The 30-stock average's early free fall briefly pushed it into "correction" territory for the first time in two years after it dropped 10% from its recent record high on Jan. 26.

The recent bout of turbulence has been sparked by fears that interest rates and inflation would spike due to the improvement in the economy. Selling also has been exacerbated by trading strategies that were betting on a continuation of market calm and low volatility.

The Dow is now back in positive territory for the year, up 0.8%, and 6.4% below its Jan. 26 peak.

Still, the rise in market volatility has slashed trillions dollars of value from stocks. And all 30 components of the Dow have had negative returns since the widely followed benchmark reached its recent high, according to market data from FactSet.

Wall Street pros cited a number of theories as to why the market was able to rebound after days of heavy selling:

Downside overshoot

Selling had become so intense in recent sessions that it caused the market to overshoot to the downside, resulting in “selling exhaustion,” says Quincy Krosby, chief market strategist at Prudential Financial. That was the exact opposite of the exuberant buying in January that drove stock prices to record highs and made the market more vulnerable to a change in investor sentiment.

Coming to grips with changing world

Investors are also coming to terms with the changing investment landscape, where stronger economic growth is seen leading to both higher inflation and interest rates. Low borrowing costs have been a major driver of the stock market advance since 2009, as cheap, plentiful cash has boosted the economy and corporate earnings. Wall Street is worried that the Federal Reserve will need to hike interest rates more aggressively than planned.

Refocused on strong economy

Investors have come to the realization that the major cause of the historic plunge was not a weakening economy or struggling corporations or too few jobs in the U.S. But rather, it is the financial fallout caused by a sudden and sharp rise in volatility that caught investors off guard. This bet on low volatility has been one of Wall Street’s most popular trades. But that trade soured Monday when there was a 100% spike in a volatility gauge, known as the VIX, to its highest level since August 2015.

That resulted in big losses for this investment strategy and caused a lot of “forced selling” at some funds, analysts say. One such fund that got trampled by the rise in volatility was Velocity Shares Daily Inverse VIX Short Term ETN, which lost 93% of its value Tuesday. Machine-driven trading via computer algorithms has been cited by many market watchers as making the selling frenzy more violent.

Return of dip buyers

A return of some buyers to the market in search of lower prices after a steep slide, a strategy known as “buying the dip,” stabilized stocks. RBC Capital Markets — citing positives such as a low risk of recession, strong earnings trends and companies returning more cash to shareholders — is one firm putting money back in the market. “For now, we are buyers on the dip,” equity strategist Lori Calvasina, head of U.S. equity strategy at RBC, said in a report.

The market is trying to find a bottom after its recent free fall, says David Kotok, chief investment officer at Cumberland Advisors, a money management firm in Sarasota, Fla.

"Whipsaw markets must run their full course to completion," Kotok said.

More: Fears of market volatility swell as stocks plunge

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It had been a swift, steep decline for U.S. stocks in a span of seven trading days since it hit its peak last month.

Pinpointing when the stock market will stop falling is “difficult,” says Terry Sandven, chief equity strategist at at U.S. Bank Wealth Management in Minneapolis.

Donald Luskin, chief investment officer at TrendMacro, offers a simpler reason why stocks eventually stop going down. “(It halts) once the algos and investors run out of stuff to sell,” he said, adding that a rebound gives investors “hope ... and that starts the healing.”

 

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