Gambler’s Ruin?

Monday’s enormous stock market rally (the FTSE 100 registered its largest ever percentage point gain, 9.8%) sent me to the history books to compare the current market volatility with that of past periods.

Here’s what I discovered at Wikipedia, using the Dow Jones Industrial Average as a benchmark (the FTSE 100 only started in 1984).

  • Only two of the largest twenty daily percentage gains have occurred in the current bear market. If that sounds a bit strange, it’s easy to forget that the largest one-day market increases tend to occur during bear, rather than bull markets, as shorts are driven to cover their positions, propelling prices higher.
  • The two recent record-making up moves were the 11.08% rally on October 13 and the 10.88% move on October 28. But there were four larger percentage moves (+15.34%, +14.87%, +12.34% and 11.36%) in 1933, 1931, 1929 and 1932 respectively.
  • Sixteen of the top twenty all-time daily percentage gains in the Dow occurred between 1929-33, compared to only two (so far) for the current bear market. Food for thought for those thinking that we might be repeating that period.
  • Three of the top twenty percentage daily Dow falls have taken place during this bear market so far. They were the -7.87% move on October 15, the -7.33% decline on October 9, and the -6.98% fall on September 29.
  • While the largest percentage daily decline was the “outlier” -22.61% move on October 19, 1987 (which in retrospect was a panic move during a long-term bull market), eight of the top twenty daily falls also took place during the 1929-33 bear, including three of the top four (Black Monday and Black Tuesday, October 28 and 29 in 1929, and also 6 November 1929, which registered losses of -12.82%, -11.73% and -9.92% respectively).
  • In points terms, however, we have seen nine of the largest ten intraday swings in the Dow during the 2008 bear, topped by the 1019 point swing on 10 October.

For full details, go to http://en.wikipedia.org/wiki/List_of_largest_daily_changes_in_the_Dow_Jones_Industrial_Average.

So while this year’s stock market volatility is the greatest all of us will have seen in our lifetimes, it’s got some way to go before we match the truly historic bear market of the early 1930s.

But (with my ETF hat on) this hugely volatile year has been extremely difficult for position traders, as even if you got the trend forecast right, your chances of being stopped out will have multiplied. Perhaps our investment textbooks should start by teaching people the concept of gambler’s ruin?  To quote Wikipedia again, this principle tells us that a gambler with finite resources will eventually go broke playing against an opponent with infinite wealth (the casino, or the stock market if seen as a whole), even if neither the gambler nor the house has an edge.

With the boom in leveraged ETFs (first double, now triple-leveraged) in the US this year, maybe John Bogle scored a major point when he criticised ETFs as encouraging gambling, to the detriment of people’s wealth.  It’s very difficult to draw the line sometimes between long-term investing and risky speculation, but it’s a challenge that we constantly face.

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