Yesterday’s stock market plunge of 998 points was the biggest intraday loss in the history of the United States stock market. The rumors are flying around about what caused this, but it appears it was some sort of trader error. Many are calling it a fat finger error that crushed the stock market. It seems someone input b for billion instead of m for million when selling a basket of stocks. The end result was relentless selling from computer trading that knocked the market way back on its heels. Between 2:45 and 2:55 eastern time on May 6, 2010, just about no one had any idea what was going on in the stock market.

The unthinkable happenings of that 998 point plunge rattled the markets and shook investors confidence in a big way. There are definitely going to be more questions in the weeks and months ahead about the safety of almost solely computer trading on the stock exchanges. What happened in this plunge was certainly abnormal, and the sooner investors know what happened and if it can be avoided again, the better things will go in the near future. The VIX has shot higher to almost 40, after sitting at about 16 in the last few weeks.

For now, the stock market is going to be extremely volatile. The confidence of the retail investor had to be hurt by yesterday’s ridiculously fast drop in stocks. Think about all the questions surrounding the market right now and you’ll realize why volatility is the name of the game. The European credit crisis, the oil spill in the Gulf, attacks thwarted in New York City, and the list goes on and on. Even as solid non farm payrolls came out today, the market is still shocked from yesterday. The lesson here is this, the stock market will have to work out the current issues and in the interim stocks will be extremely volatile. I think investors would be wise to make out a list of names they think might be good buys and get ready to get into the market if the panic gets overdone.

In the past couple of months the bulls have staged a nice rally off the lows in the stock market and the volatility has been rather low. The wind behind the back of the rally has mainly been a slightly less discouraging economic outlook than was previously given, though it is still quite gloomy. Now that the market in many cases is up at least 20% from its lows the bar will be raised and the volatility is likely to come back in a big way.

The average investor needs to be very careful to not fall into the trap of assuming that the lower volatility and calm days of the last two or three months have now become the norm. They were the norm for that period of time, but I believe volatility and a real fight between the bears and the bulls will lead to many more choppy sessions in the months ahead. Even if you take away the current state of the market and the economy, the period we are entering is generally one that is quite a bit more volatile. As the summer months come and go and then traders return in a big way in September and October we usually see the most volatile time of the year.

The VIX, a guide to the volatility in the overall market and the amount of fear in the market,  has slowly moved down to about $30 per share in the last few weeks. I think it’s a safe bet that the VIX will see higher levels in the months ahead as investors try to digest economic news and determine whether things really are getting better or not. As I have stated in the past, it is now becoming clear that less bad will no longer be good enough for the stock market. The nation’s economy is still in a big mess and until that completely resolves itself one would be ignorant to assume that volatility will remained subdued.

The last couple of days have made it abundantly clear, volatility is still the name of the game in the stock market right now. Consecutive days of a loss of 335 points and then a gain of 279 points on the Dow used to be a very rare occurrence but now it is simply become the norm.

What exact does this volatility in the stock market tell us about the current state of the economy and the confidence of investors? It tells us that investors are very uncertain about what is next for the economy and at this point they are unable to make any stable hypothesis as to when things will get better. Rather than a stable market that tries to find its footing we have a market that is full of uncertainty and is as fickle as any market in decades. One day investors may be encouraged that things may not be quite as bad as they feared, while the next it feels as if the sky is falling.

What should the average investor do in this kind of environment? The key is to not read too much into daily movements of the market. The wild swings up and down are likely to continue, but until the volatility begins to level off it will be very difficult for the individual to make money in the stock market. It is fair to say that in a period with so much uncertainty and so much volatility there is a much greater risk to the average investor than there is reward.

This doesn’t mean you can’t invest in anything or you shouldn’t be doing your homework on companies you might invest in sometime down the road. It is always a good idea to be ready for the time when it comes, but also realize that turning the calendar into January has done nothing to change the sentiment of the market. Tread with extreme caution during these volatile days.