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What is behind market swings? List is long

So much for a quiet August on Wall Street.  The stock market hit another air pocket Wednesday, sending market indices plunging. Traders say: "Get used to it."

So much for a quiet August on Wall Street.

The stock market hit another air pocket Wednesday, sending market indices plunging and dousing a brief moment of optimism generated by Tuesday's big gains.

"It's turned into a true, crazy day traders market," said Steve Grasso, head of institutional sales at Stuart Frankel, from the floor of the New York Stock Exchange.

After surging 429 points on Tuesday, the Dow Jones industrial average plummeted more than 520 points Wednesday, giving back all their gains and then some in another wild trading session.

Traders and investment advisors offered timely advice to individual investors: "Get used to it." Stock prices are going to continue to swing sharply, they said, as long as doubts remain about Europe's debt crisis and the outcome of political battles over the federal budget.

"The volatility in and of itself is going to be a problem for individual investors," said Art Hogan at Lazard Capital Markets. "I think in the long run we're going to have to get used to it until we get those two things answered."

The list of unanswered questions for investors seems to keep growing. On Monday, the global financial markets began their first trading day in a world where the U.S. government no longer enjoyed a top-notch AAA credit score from the three major rating agencies.

On Tuesday, Wall Street had hoped to get a better picture of the Federal Reserve's response to worrisome signs that the U.S. economy may be slipping back into recession. But at its first official meeting in six weeks, a deeply divided board took the unusual step of extending its low-interest-rate pledge until mid-2013, suggesting it has little confidence in its forecast for a pickup in growth.

"That truly told the investing community that the Fed doesn't know what to do," said Grasso. "I don't know if anybody still believed in the inner circles that Chairman [Ben] Bernanke was the all-knowing power, the Wizard of Oz. But I think at this point we see that there's really nothing behind the curtain."

The Fed has other options, including a controversial idea to renew massive bond purchases to pump more cash into the economy. But after spending $2.4 trillion since the Panic of 2008, the Fed's easy-money policies have failed to boost growth to levels typically seen three years into an economic recovery.

The Fed also offered a gloomier assessment of the economy, saying growth is “considerably slower” than expected and that temporary factors like the Japanese earthquake and higher oil prices are only partly to blame. In doing so, the central bankers all but acknowledged they have been powerless to offset the lasting impact from the collapse of a decade-long, global borrowing binge.

The Fed is also largely powerless to help European governments battle the rising threat of debt defaults. As weaker Eurozone economies respond with stepped-up austerity measures, those economies also face a higher risk of slipping into recession.

"Zero percent interest rates can’t make European debt solvent," said Michael Pento, senior economist at Euro Pacific Capital. "And two more years of free money won’t automatically repair America’s severely damaged public and private sector balance sheets."

With the Fed out of meaningful remedies, fiscal stimulus — the use of federal tax and spending policies to promote growth — has historically offered another option to revive growth. But political paralysis in Washington, driven in part by fierce Republican opposition to more government spending, has all but eliminated that option.

With the government virtually out of options, and the risk of recession rising, investors are growing concerned that companies could face pressure on profits, which have been relatively strong over the past year or so. It is that uncertainty that has been whipsawing stock prices, sending broad market indices down nearly 17 percent over just 13 sessions.

"It's now about 50-50 as to we whether we dip back into negative (economic growth) territory for a quarter," said Roger Altman, an investment banker and former Treasury official. "Under those circumstances the market is resetting itself in reflection of that, and appropriately so".

The daily stock price surges and plunges have been amplified by the growing use of electronic trading that has replaced much of the traditional auction system supervised by human "specialists."

In the past, those market makers were charged with tamping down big prices swings by stepping in to buy when there were no buyers and selling from their own holdings when the supply of shares temporarily dried up. Today, the bulk of trading is handled by computers.

"You don't have any policemen anymore," said market strategist Laszlo Birinyi. "You don't have the specialist in the market who has fiduciary responsibility. No one has responsibility for stopping trades. The market maker now is more concerned with his own book than he is worried about his responsibilities, because he has no responsibilities."