When it comes to forecasting stock market trends, two things are especially useful - experience, and math.
In this article I'll attempt to give you both. I'll give you the math part using statistics, and the experience part using my 30 years as a professional investor. I won't use complex formulas or weird-looking charts for the math parts. I'll instead try to use charts and tables that are intuitive and only require common sense to understand.
I'll begin with a couple of definitions of the terms I'll be using.
The 1% Club
Since 1950 the market has gone up or down each day, on average, by a little less than 1 percent (0.96% to be exact). This is our base line, and it translates statistically into 1 standard deviation in price change. Two-thirds of all trading days since 1950 have fallen within this range.
Based on today's price of 3130 for the S&P 500, this means that it's normal for the market to be up or down by 30 points. But the market lately has been moving up and down each day by far more than that in 2020.
The question I want to address is, how abnormal have the recent daily market moves been, and what does it mean going forward? Should you get out of stocks altogether? Should you buy the dips? Should you stand pat?
If the daily swings in market valuation stay within the 1% boundaries - up or down - there's no compelling reason to change the way you're invested. Steady as she goes.
But what if the market begins to act up and go outside the 1% boundary and moves closer to 2%? That comes next.
The 2% Club
This is where we get into statistics, because a 2 percent move in the market on any given day is a rare event. How rare? Only 5 percent of all trading days since 1950 have fallen outside the 2% range. That's rare, but not as rare as what we've been experiencing lately. Statisticians call this a 2-sigma event, or twice the normal daily market change.
We've had 6 days so far in 2020 where the market moved beyond the 2% range. Normally, we only get 2 or 3 days per year with moves this big. Something significant is happening in the market.
The 3% Club
As you would expect, the 3 percent club is even more rare, and yet we've experienced 5 of these ultra-rare days in 2020 (so far). How rare are these 3-Sigma market day events? Since 1950 we've had 108 days where the market was down by 3% or more, and 101 days where it was up by 3% or more.
To experience 5 days of 3-Sigma events in such a short time in 2020 is very rare indeed. You would have to go back to the Global Financial Crisis in 2008 to find a similar string of 3-Sigma events. There were 40 days in 2008 that exceeded the 3 percent threshold, and that was over a full 12 months. This year is just getting started.
The 4% Club
The 4% Club only has 89 members out of a population of 17,600. Only two are from 2020. To make it into the 4% club you have to have some kind of an edge. A possible pandemic fits the bill, and so does an imminent recession. Keep an eye on daily market moves of 4% or more because they can be a sign of things to come.
Final thoughts
We're going through a rare period in market history. Daily volatility is off the charts. Bulls are being seriously challenged by bears. Dip-buyers are trying their best to turn things around. The Fed is here to help. Will any of this matter when the recession gets here? My answer is no, which is why I advocate a defensive strategy.
Contact me if you would like to discuss ways to protect your invested wealth. info@zeninvestor.org