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By Sarah Modlock

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It's not the best way to start the day. Surrounded by high-pitched news of stock market plunges and rumours of recession, we are left worried, confused or both. But how serious are the events of the last few days and how do they impact on the average man or woman in the street?

What has happened?

European stock markets experienced big drops on Monday, 21st January. Around £77 billion was wiped from the value of the FTSE 100 in its biggest one-day fall since the September 11 terror attacks on the US, closing at 5578.2 - down 323.5 points. When the markets opened the following day, nerves had taken hold. Volatile trading saw the FTSE 100 drop 4% in early trading, only to recover 2.85% to 5737.0 by market close. Further turmoil is expected in the coming days.

Over the last 3 months the FTSE 100 has fallen by nearly 15% from 6,730.70 to 5737.0: http://uk.finance.yahoo.com/q/bc?s=%5EFTSE&t=3m

Overnight the Asian markets fell, with Japan's Nikkei index down 5.5% and Hong Kong's Hang Seng more than 9% down just before the end of trading. Further turmoil is expected.

What has caused this?

The panic in world markets comes at a time when investors are nervous about economic downturns and the risk of recession. But it is said that when America sneezes, the rest of the world catches a cold. On Friday last week US President George Bush announced a package of tax cuts and other measures worth £72 billion. Although this was supposed to have a reassuring effect it was viewed as disappointing and caused many to worry that things were worse than they feared. Wall Street was closed on Monday for a national holiday, but that didn't stop financiers across the pond getting anxious.

Of course the credit crunch which has been rumbling for many months began life in the US, where repackaged debts from the sub-prime mortgage market lost value as low income homeowners struggled to repay their loans and the market collapsed. Banks stopped lending to each other and the jitters began. Reports emerged on Monday that Bank of China was about to announce huge write-downs from exposure to US sub-prime mortgages, with the bank's shares suspended ahead of an announcement. Germany's WestLB said it expected a net loss of one billion euros ($1.4bn; £740m) because of its sub-prime exposure.

Why does America matter so much?

Many investors around the world put their money in US shares. And of course the US represents huge retail and wholesale business to just about every other country in the world. Even if you do not directly rely on the US the chances are that someone you do business with does and everyone can expect a knock-on effect when their economy struggles.

How could it affect me?

In the short term, if you own stocks and shares or share-based investments such as ISAs, these are likely to be worth less at the moment. The crucial thing to remember is that investment is a long term strategy and any short term fluctuations or corrections need to be taken in context with a five - or 10-year view at the very least. All markets dip from time to time but over five or 10 years and beyond any bumps will be smoothed over by more neutral or much better performance. So sit tight. Selling now will almost certainly mean you lose cash but if you hold on your investments will have the chance to recover. Lower prices for shares could also represent a great buying opportunity for many investors.

Even if you do not invest in the stock market, any economic downturn could affect your employer, making jobs less secure. Banks will also tighten their belts and be more strict about lending which could make it harder for people to get mortgages or borrow money at lower rates.

Of course our pensions are all invested in shares and so these will have experienced a dip too. As with other investments, the trick is not to panic. If you are a long way off retirement then this should not affect you. "As pension funds are long-term investors, there is no reason to believe short-term stock market falls will have a significant impact on workplace pensions," says Nigel Peaple of the National Association of Pension Funds (NAPF). "In any case, pension funds invest in a range of assets, so to some extent, they are cushioned from such movements. Recent volatility will also not affect the ability of schemes to pay the pensions due to their members," he says.

If you are close to retirement then it is likely your pension fund will already have been placed into safer investments or taken away from the stock market altogether - something which is common practice to ensure that those about to retire are not affected by share crashes. Talk to your pension provider if you are in any doubt.

What will stop the rot?

Unfortunately there's no magic bullet but part of the trick will be persuading US investors and also UK investors - you and me - not to panic. The Federal Reserve - the US central bank - has been cutting interest rates and hinting at further cuts including a surprise one today when rates were lowered to 3.5%, a shock three-quarters of a percentage point reduction.
There may be a cut to UK rates which will help restore confidence. It remains to be seen whether this is just a bad week, month or year for world markets. No one is sure whether we have already seen shares go as low as they can or whether we need to hold tight for a longer rollercoaster ride.

For what it's worth, a spokesman for Gordon Brown said the volatility in the financial markets was "clearly a global phenomenon" and that the Prime Minister believes Britain is "well placed to withstand this uncertainty".