Let’s Make Our Own Hypothetical Stock Market

One of the points I stress to investors is just how much noise there is in everyday trading. Simply put, the stock market moves around a heckuva lot compared with what value is actually being created.

I ran the numbers going back to 1957 and found that the S&P 500’s average daily gain works out to 0.0255%. Roughly speaking, that means for every $39 you have in the stock market, you make an average of one penny in capital gains each trading day. Snoozeville, right?

Yet the average daily swing is about 40 cents. This means that you’re seeing 40 times the volatility of the value that’s actually being created, each day. That’s more than 97% noise.

We can use some basic math and a random number function to create our own hypothetical stock market. I’ve attached a spreadsheet which contains our phony market.

I’ve used the calendar for the 2013 trading year as our template. It contains 252 trading days. I’ve set our index to 100 at the start of the year. Each day, the index gains an average of 0.0255%. The random number generator gives us a standard deviation of 1%.

(This is not quite accurate due to the nature of fat tails. I ask the more numerate among us to leave that issue aside for now, since it doesn’t detract from my point. In fact, it supports it.)

Once you’ve downloaded the spreadsheet (and assuming I’ve done this correctly), you can simply point your cursor to an empty cell and keep hitting “delete,” and the chart I’ve made should refresh. Here’s the point: You can just see how many wildly different stock markets we can make solely on the basis of random numbers.

There’s no trend or QE or anything going on. It’s just random, but it’s based on the market’s same stats of the last 56 years.

Posted by on October 13th, 2014 at 12:23 pm

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.