The Importance of Extreme Events

Over the 116 years of its existence, the Dow Jones Industrial Average has risen by 4% or more in a single day 138 times, which works out to about once every ten months.

Now if we take the combined gain of these 138 days, it comes to more than six times the entire gain of the Dow over its entire 116 years.

In other words, most of the stock market’s gain has come on just 0.5% of the trading days. The other 99.5% of the time, the market is a net loser (this is just capital gain, not dividends).

Now let me stop for a second. While these stats are accurate, they’re slightly misleading. The problem happens with extreme events — at the far tails of the distribution. For example, the 138 days aren’t evenly spread out. Seventy of those days, a slim majority, came during the 1930s. There were only two 4% or more days between Pearl Harbor and JFK’s assassination.

The lesson is that finance tends to move in two speeds. The vast majority is slow and boring. Then, very suddenly, things get very, very dramatic.

Posted by on September 26th, 2012 at 11:05 pm

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