Editor's note: Don't get lulled into a false sense of security...

Until recently, stocks have been on a one-way trip higher. But current volatility has some investors spooked. And while you might take comfort in the market's fail-safes – restrictions designed to reduce panic-selling – Extreme Value editor Dan Ferris is warning you not to get complacent...

In short, markets don't care about the rules. And humans can't control the markets, no matter how many rules they put in place.

In today's Masters Series, originally from the January 22, 2021 Digest, Dan explains why the market's "circuit breakers" are meaningless... why he expects even more volatility this year... and why you should consider every possible market surprise – no matter how unlikely it might seem...

The Truth Will Find Us Through Volatility

By Dan Ferris, editor, Extreme Value

At the start of last year, I warned investors about an event that's not even allowed to happen...

My warning came during the first Stansberry Investor Hour podcast of 2021.

I was delivering my annual list of 10 events that would surprise investors throughout the year. The first and most outrageous of my "Top Surprises of 2021" was simple...

I said the biggest surprise of this year – or any other, for that matter – would be if the benchmark S&P 500 Index were to fall more than 20% in a single trading session.

Of course, I know that didn't happen. And I'm sure the keyboard cowboys have probably already started typing their e-mails... They're mumbling to themselves that the market's "circuit breakers" make that impossible.

In case you're unfamiliar, circuit breakers are rules put in place to halt trading in individual stocks or on whole exchanges if they fall by a certain percentage during the trading day. They're designed as a way to clear order backlogs and give investors time to calm down.

In short, they're the market's solution to help stop "panic selling."

The stock exchanges currently have three circuit breakers in place... If the S&P 500 Index falls 7% during a session, the circuit breakers halt trading for 15 minutes. Then, the market reopens and trading resumes. If the index falls 13%, a second circuit breaker triggers another 15-minute trading halt. And if the market keeps falling, the exchange closes as soon as it's down 20%.

At the very least, you must concede that an event prohibited by stock exchange rules would be a huge surprise if it actually occurred. It's not allowed to happen... The rules say so.

And let's be clear – when I talk about this big surprise, I'm not talking about a 20.001% decline. I'm talking about stocks plunging 25%... 30%... maybe even 40% in a single day.

But before we go any further, I wasn't predicting this type of market collapse would happen. And I fully understand it's highly unlikely to occur at all... even if exchange rules allowed it.

So if it's unlikely and not allowed to occur, why did I insinuate that such an event could happen?

I discussed the philosophical underpinning in my November 13, 2020 Digest. In that essay, you may recall that I said, "Mankind cannot manage nature from the top down."

Men and women are a part of nature... and so are all the societies and markets they create. We can no more manage the outcomes that nature generates than choose to live without food or water. To put it simply, we are all bound by the limits of nature.

That doesn't only apply to marvelous scientific quests like achieving "escape velocity" from the atmosphere to facilitate travel in outer space... It includes every single thing that every human being does.

That humanity's goods and services are created by humans makes them no less subject to the laws of nature – whatever they might be – than the shelters, tools, and instinctual behaviors made, used, and performed by other animals.

We don't really know nature's limits until we crash into them.

And Mother Nature doesn't care what the stock exchange rules say...

Filmmaker Cecil B. DeMille captured my message's intent well when he said, "We cannot break the Ten Commandments. We can only break ourselves against them."

Humans think they make the rules, but they don't. Mother Nature makes the rules... And our attempts to model nature's rules are mostly in vain and destined to fail.

I believe the market's circuit breakers don't mean a lot for the same reason that 100-year flood levels don't mean a lot... The basic idea is that the highest level ever reached before this very moment represents some meaningful limit on future flood levels.

The assignment of a time frame like "100 years" or even "500 years" is blatant intellectual fraud. Nobody knows when the highest flood level in any given region will be exceeded.

It could be in 211 days, 375 weeks, or 921 years...

Assigning the number falsely anchors us on centuries-long time frames, giving the impression that it won't happen if it has only been 99 or 499 years. It makes us, as humans, think that we know the probability and timing of such events... But we don't.

But the real problem, once again, is believing we know nature's limits simply because some extreme was hit in the past.

Remember, before the current record flood level, folks thought the previous one was a meaningful representation of nature's limits, too... But it wasn't. It never is.

We don't know Mother Nature's limits. And when she's finally in the mood to share them with us... you don't want to be anywhere nearby.

And no, the fact that we as humans can measure the speed of light, the speed of sound, and other phenomena doesn't mean we know nature's limits. It just means we know how to measure stuff... And even then, are we measuring a table with a ruler or a ruler with a table? It's not always easy to know.

The circuit breakers are more like levees of a finite height than an inviolable limit on market moves...

Officials implemented the circuit breakers after "Black Monday" in 1987, when the Dow Jones Industrial Average lost more than 22% in a single trading session.

The original circuit breakers have been modified multiple times, most recently after the "Flash Crash" of May 6, 2010. That day, the S&P 500 plunged as much as 9% – with much of the drop occurring in a brief span in the afternoon – before rebounding within minutes.

Frenzied trading continued, though... because the first circuit breaker was set at 10%.

Nowadays, as I said earlier, the first market-wide circuit breaker is at 7%... And it was triggered four times in 2020. Before that, it had only been reached once in its history – in October 1997. And to this day, the index has never hit the 13% or 20% circuit breakers.

It's easy – facile, I would say – to argue that the circuit breakers are obviously working because the market has only ever hit the first one. That's certainly what anyone married to the market's status quo will tell you...

For example, at 9:34 a.m. on March 9, 2020, the 7% circuit breaker was tripped... halting trading for the next 15 minutes. After trading resumed, the market didn't go down much further. It closed down 7.6% on the day, causing traders to gush to Wall Street Journal reporters that "cooler heads are prevailing," and "the systems, as designed, worked."

That's like someone saying... "You see, the water rose 100 feet in the highest flood ever... So we built 110-foot levees, and then the water only rose 109 feet the next time it flooded. The systems, as designed, worked."

But the thing is... it doesn't indicate that the systems worked as designed. It only indicates that you got away with it this time. There's no law of nature that says the floodwaters can't rise 120 feet or more the next time.

At this point, the keyboard cowboys are probably thinking, "You're all wet, Dan. Floods are natural events. The markets are controlled by humans. It's apples and oranges."

You go ahead and believe that. I'll keep believing that it's pure hubris to think human rules trump nature and that market extremes aren't as unknowable as future high-water marks.

And no, I'm no expert on floods or the inner workings of financial exchanges. A lot of folks in this world know a lot more than me about both of those topics.

But it's funny... Knowing more didn't prevent Black Monday, the Flash Crash of 2010, or the multiple times in 2020 when the market's circuit breakers were tripped.

The manmade circuit breakers also didn't prevent Meta Platforms (FB) – formerly Facebook – from falling nearly 25% on July 26, 2018... or more than 26% on February 3.

By rule, individual stocks of that size aren't allowed to move up or down more than 10% without a trading halt. But where were the rules that day?

Now, if you look up the specific rules and tell me that Facebook's plunge didn't exactly violate them, OK... But my one and only point is that, rules or no rules, it happened.

Facebook plummeted very quickly. I remember it well... Less than a year earlier, I had warned attendees of our 2017 annual conference in Las Vegas that it could happen.

Why couldn't that same thing happen to all the mega-cap stocks on the same day? Is there any answer that doesn't reduce to "because the rules won't let it happen"?

What makes you think the folks calling the shots know how to prevent such a market-wide event – a 100-year market flood, if you will – just because it hasn't happened so far, and just because the rules say it's not allowed to happen?

The rules say you're not allowed to do heroin, either... But I bet you could get all the heroin you want in many big cities in America right now.

That's because markets – financial, drug, or otherwise – don't care about rules. Rules are static. Markets are dynamic. They do what markets do, not what humans want them to do.

Calling the rules "circuit breakers" likely contributes to the false sense of security they provide...

As William Shakespeare once wrote in his play Romeo & Juliet, "What's in a name?" It doesn't matter what you call them. Nature doesn't care about manmade titles.

And I'm not even saying the circuit breakers don't mostly work, similar to how seat belts mostly work. But sometimes, seat belts can kill you... And nobody ever talks about that.

I like to discuss things about which people pretend to have little doubt. And that's especially true when it's some manmade thing that's supposed to make us safer.

Markets aren't safe because of the exchange rules. They work the way they do because of stuff we don't control... They have a life of their own, based on unfathomable, uncontrollable, unregulatable inputs from millions of participants every minute.

Don't be so confident in humanity's works that you forget who's running the show. (Hint: It's not humans.)

At this point, I must clarify that this isn't a prediction – it's a potential surprise.

My surprises aren't predictions... Regular Digest readers know I don't make those. I'm not predicting that the S&P 500 will lose more than 20% in a single day this year (and I wasn't predicting it last year, either).

Like I said, exchange rules or not, I know it's highly unlikely to happen. But I'm willing to bet that it's still more likely than almost any stock market participant on Earth believes right now. That's the point.

I want to get you thinking about events that you're "certain" can't happen. Remember the third Delphic entrance maxim... "Surety Brings Ruin." Surety about future events in vast, volatile markets must be among the worst violations of that entrance maxim.

If you're still not convinced this is worth thinking about today, I implore you to reconsider...

The ultimate point of making a list of potential surprises – rather than making predictions – is to point out events that aren't on most folks' radar screens... as indicated by current valuations, sentiment, and recent price action.

By being ignorant to these potential surprises, they're vulnerable to risks for which they're totally unprepared.

Also, by focusing on the ways that the market might surprise you, it helps you avoid the typical human foible of believing the near-term future will resemble the near-term past... Anybody who thought that way in February 2020 was certainly bludgeoned about the face, neck, and wallet with what has easily been the single biggest surprise of my lifetime.

At the very least, I hope you'll agree that it's probably dangerous not to contemplate the occurrence of events widely agreed to be "too unlikely to consider."

Like last year, if my list of potential surprises for 2022 has a theme, it's that I expect a ton of volatility this year...

To sum up my thoughts simply... In a bubble, almost any kind of extreme volatility would come as a surprise to most investors – except the kind that makes prices go up, of course.

A young investor named Christopher Cole, the founder of Artemis Capital Management, is the poet laureate of volatility today. As he writes on the asset-management firm's website...

Volatility as a concept is widely misunderstood. Volatility is not fear. Volatility is not the VIX index. Volatility is not a statistic or a standard deviation... or any other number derived by abstract formula.

Volatility is no different in markets than it is to life...

Regardless of how it is measured it reflects the difference between the world as we imagine it to be and the world that actually exists...

We will find a way to prosper if we relentlessly search for nothing but the truth, otherwise the truth will find us through volatility.

And if you're craving a nugget to take away from today's Masters Series, I encourage you to consider the words of the lone "voice" crying out in the Bible verse Isaiah 40:3...

The voice of him that crieth in the wilderness, Prepare ye the way of the LORD, make straight in the desert a highway for our God.

Volatility is truth... and God doesn't like liars.

So prepare ye and your portfolio for the way of the Lord. Make straight a highway of prudence, discipline, and "true diversification" through the desert of speculative excess.

Now, I want you to tell me this...

Have I wasted your time today by contemplating events that stock exchange rules don't even allow? Would you rather not worry about the possibility of unlikely events, sit back, and just let the truth find you through volatility, to paraphrase Cole's quote?

Or are you grateful for my latest attempt to jar you out of complacency, as the biggest bubble in history passes in front of you like the worst 100-foot flood in the past 99 years?

I know which one I would pick.

Good investing,

Dan Ferris

Editor's note: If the market volatility has reminded you of what a real crash feels like, Dan says there's still time to take action before things get worse. In short, this is the moment to do your future self a huge favor – using a top-to-bottom strategy to protect your savings and more...

Dan recently released his "game plan" for the looming market crash, featuring a group of stocks that could outperform everything else for the next five to 10 years. Plus, he shared a unique defensive opportunity with 1,500% upside potential. He says this could be the single best stock idea he has ever had... Click here to learn more.