I still have pleasant memories from an evening with friends at a casino in the German town of Baden Baden many years ago. We were backpacking through Europe, and the evening did not start well, with the casino doorman insisting that we wear jackets and ties.

The casino did offer a clothes rental service that set us back several euros, which of course did not go down well with budget travelers. Despite the initial setback, we ended the evening with a memorable meal in a top-notch restaurant courtesy of our winnings from the roulette table.

Those winnings aside, I do not care much for gambling—the risk-return trade-off isn’t attractive and the outcomes are too unpredictable.

Unfortunately, investing in the stock markets feels increasingly like gambling. Just think of the typical market reaction to a slight earnings miss matched with earnings guidance less than the analysts’ consensus.  You can bet there will be a 5% to 10% price drop.

Canadian examples from this market madness include the 27% drop in the price of TMX Group (TSX: X, OTC: TMXXF) in December  immediately after Nasdaq announced its entry into the Canadian equity-trading market. A similar fate was recently meted out to Rogers Communications (TSX: RCI/b, NYSE: RCI) when the quarterly results were slightly below expectations, leading to an 8% decline in the share price over two days.

These short-term moves rattle even the most disciplined long-term investors. Our “noise meter,” which measures stock price movements over rolling five-day periods, provides a good indication when market forces push a share aggressively in a certain direction. For TMX, that direction was down, with our noise meter showing a sharp drop after Nasdaq’s announcement.

The question is how long-term investors should react to bouts of extreme stock volatility. One approach is to follow the advice of Warren Buffett, as explained in his 2014 letter to investors:

“It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his—and those prices varied widely over short periods of time depending on his mental state—how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.

Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally as well. Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits—and, worse yet, important to consider acting upon their comments.

Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of “Don’t just sit there—do something.” For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.

The key to this approach is to know the fair value of your investments and to profit from irrational market behavior. Unfortunately, many investors struggle to estimate the fair value of their holdings and are lost when share prices fluctuate wildly. To this end, we regularly publish our estimates of the fair values of our Dividend Champions that investors can use to gauge whether price movements are overshooting either positively or negatively.

Another approach for investors to manage market volatility is diversification. Volatility at the portfolio or market level is considerably lower than for individual stocks. Market dismay with a marginal earnings miss may be countered with a “beat” by another holding. When we apply our noise meter to Standard & Poor’s 500-stock index, it is clear that short-term market movements are usually contained within fairly narrow bands with the occasional overshoot, such as those in 2008 and 2009 during the global financial crisis.

A final approach to manage market volatility is simply to hold a reasonable portion of cash. True, the yields on savings accounts are abysmally low at the moment, but cash is a calming force and does allow investors to take advantage when the market’s mood swings offer opportunities.