9 Ways to Explain the Stock Market in Layman's Terms

"What happened to the bull market? Where did it go?"

After 11 years of good times, we must realize there are investors who have never seen a down market before. Investing became a leisure-time activity, something you could do on your smartphone from anywhere. Then came the market decline. This takes some explaining.

Let's assume your clients aren't in the "do-it-yourself" camp. They came to you for advice. Deep down, their concern is: "I did what you suggested. I didn't do anything wrong. Why am I being punished? Why is this happening to me?" You can go into technical explanations using historical charts, but sometimes people need common-sense analogies from everyday life they can understand.

What's the Stock Market Supposed to Do?

A little refresher might help. Investors own shares in companies. Companies have earnings. The price-to-earnings (P/E) ratio should tell us what's the proper level for the stock price. If a company has annual earnings of $1 per share and the price/earnings multiple is 10, the stock should be selling around $10. If down the road, the company has earnings of $1.50, the stock should be selling at $15, assuming the P/E ratio hasn't changed. Companies do everything they can to increase earnings year over year.

The stock market is considered a leading indicator of the economy. If it looks like things are improving, continuing to improve or expected to improve, the stock market should be rising. If the situation looks to be deteriorating, the stock market should go down.

A third reminder is that, theoretically, when a share of stock changes hands, it's because the seller thinks it's time to get out, while the buyer thinks it's a good time to get in.

Common-Sense Explanations for Stock Market Volatility

One day, it looks like the "rules" went out the window. Clients wonder "Why is this happening to me?"

1. The stock market is like an unruly child. You've been in the supermarket. Someone has a young child, screaming at the top of their lungs, testing their parent's patience. It's not a diaper changing situation, it's "I want something. You aren't giving it to me. You are going to pay the price."

Like the temper tantrum, the stock market volatility needs to run its course before life returns back to normal.

2. The stock market is like your child. You want the best for your child. They stumble and bruise themselves. You pick them up, kiss the wound and tell them it will be all better. You are disappointed when they get bad grades. You try to help them get better grades. You sacrifice to give your child the best future possible. Raising your child has its high points, but it's not always an easy journey.

Like your child, the stock market has setbacks. If you have faith in the long-term strength of the U.S. economy, you feel the stock market will eventually fall into line.

3. The stock market is like a rubber band. You stretch a rubber band. It becomes longer. You need to keep the tension up, otherwise it snaps back to its original shape. On the positive side, at that point, it's ready to be stretched again.

The stock market may soar or plunge, much like the rubber band stretches.

4. The stock market is like someone who overeats. Ever watch those hot dog or chicken wing eating contests? What do you suppose the winner does after stepping off the stage? You've heard of people who binge and purge.

The stock market goes through its own binge and purge cycles. People talk about corrections, bull and bear markets.

5. The stock market is like a pendulum. You know they swing back and forth, sometimes in an arc. You've seen a metronome on a piano. Maybe you've seen that desktop gadget with five steel balls suspended by thin cords. You lift one, it smacks into the four stationary balls, sending the last one flying in the opposite direction. Left to itself, it eventually slows down, because there's no such thing as a perpetual motion machine.

The stock market can gyrate in both directions. Hopefully, it eventually slows down.

6. The majority is always wrong. We love websites that score restaurants and hotels based on reader feedback. Presumably, a restaurant with the best score from the most people delivers the best experience.

Unfortunately, this rarely works with the stock market. The instant the majority of experts say: "Nothing can stop it now" it tends to change direction. That's probably why many analysts and strategists hedge their forecasts: "We are cautiously optimistic."

7. Buy on anticipation, sell on realization. That ties in with the above example. If the stock market is considered a leading indicator, once the goal has been reached, what's left?

It's also known as "buy on cannons, sell on trumpets."

8. The market can turn on a dime. Actually, the market has changed direction when everything looks like all hope is lost and things cannot possibly get any better. It's the "cannons and trumpets" analogy.

This is the logic behind why market timing rarely works. The time to get in is when you feel no sane person would be buying. It's part of the logic for why using money managers is a good strategy, because they take the personal emotion out of the equation.

9. The market is like two superheroes fighting. There are enough movies out to make this analogy familiar. Two incredibly well-built comic characters slug it out. Wall Street's analogy has been bulls and bears.

At different times during the fight, you can make the case why one side or the other might prevail. You have a favorite that you cheer for.

These examples are not based on modern portfolio theory or any textbook logic. They are mean to be easy to understand common sense analogies where the average person can conclude "It usually works out in the end." You can't predict the future, but you can compassionately relate to your client's situation.