Blogger Nickel at fivecentnickel.com made some great comments to my post about missing the 10 best days in the stock market. I showed in my post that the probability of missing the best 10 days in 10 years is one in 2.8 billion billion billion. Nickel disagreed. Because the comments require a long response, I'm making a new post as opposed to burying it in the comments. First, the comments from Nickel:
"While you're correct that this overstates the problem in that people won't miss just the 10 best days of the market, you're forgetting that the biggest days often come in the earliest stages of a recovery.
"For example, looking over the past 25 years, three of the 10 biggest days came in the week and a half following Black Monday, and two more of them occur in close succession at the very tail end of the dot bomb debacle. Thus, these days are concentrated into periods when people are especially likely to have bailed on the market and not gotten back in.
"Consider the scenario in which sometimes gets smacked on Black Monday, jumps out of the market to lick their wounds, and then immediately misses gains of 9.3%, 5.3% and 4.9%. They've now locked in a huge loss that they had little chance of avoiding in the first place, and they also missed out on a huge recovery.
"Calculating the probability that people will randomly miss the ten best days is a *huge* oversimplification, and it casts doubt on your entire argument."
I want to thank Nickel for the comments and address the issue of best days coming right after the stock market bottom. Since he brought up Black Monday in 1987 and the dot com bubble, let's take a closer look.
Black Monday was October 19, 1987. The S&P 500 dropped a whopping 20.5% on a single day, from 282.70 to 224.84. Let's say a nervous investor sold the very next day on the open. The price was 225.06, close to the bottom made on the previous day. In the next 10 days, he would've missed 3 of the 10 best days in the next 20 years, which had returns of +5.33%, +9.10%, and +4.93% respectively. Does it mean this investor missed a total of (1 + 5.33%) * (1 + 9.10%) * (1 + 4.93%) - 1 = 20.6% of returns? No, after 3 best days passed, S&P 500 closed at 244.77 on 10/29/1987, up 8.8%, not 20.6%, from the 225.06 level he sold at. A little over a month later, on 12/3/1987, the market returned to 225.21, which was about the same level as the previous bottom. Now, having missed 3 of the 10 best days in the next 20 years, this investor didn't suffer any damage if he got back in a month and half later.
| Date | S&P 500 Close |
| 10/16/1987 | 282.70 |
| 10/19/1987 | 224.84 (sold here) |
| 10/20/1987 | 236.83 |
| 10/21/1987 | 258.38 |
| 10/29/1987 | 244.77 (missed 8.8% of gains) |
| 12/03/1987 | 225.21 (back to where it was) |
Now, let's look at the same for the 2 best days in 2002. On 7/24/2002 and 7/29/2002, the S&P 500 had two best days, up 5.73% and 5.41% respectively. By then the bear market had gone on for over two years. If an investor was nervous, he would've sold way before then, perhaps in early 2001 when the S&P 500 dropped to 1,300 from 1,500 in the previous year, or in early 2002 when the S&P 500 dropped more than 20% in two years. For argument's sake, let's say our unlucky investor sold right before the best days, on 7/23/2002, at the close of 797.70. After two of the 10 best days in 25 years, the market closed on 7/29/2002 at 898.96, up by 12.7%. Was that a permanent loss of opportunity if the investor missed those two best days? Once again, no. 2 months and 10 days later, on 10/7/2002, the S&P 500 went back to 785.28, lower than the 797.70 price before the best days.
| Date | S&P 500 Close |
| 1/3/2000 | 1,455.22 |
| 1/2/2001 | 1,283.27 (down 12% from a year ago) |
| 1/2/2002 | 1,154.67 (down 21% from two years ago) |
| 7/23/2002 | 797.70 (sold here) |
| 7/24/2002 | 843.43 |
| 7/29/2002 | 898.96 (missed 12.7% of gains) |
| 10/7/2002 | 785.28 (lower than where it was) |
Will the market always return to the previous low before the best days? I don't think anybody has an answer to that. The market is volatile and unpredictable. I continue to believe that (a) it's impossible to miss only the 10 best days; and (b) even if some best days were missed, the damage isn't nearly as bad as those meaningless stats imply.
Suppose calculating random odds is a *huge* oversimplification like Nickel said, and because the best days often come in the early recovery days, I'm off by a factor of a billion. That is huge, right? Say instead of one in 2.8 billion billion billion, the odds of missing the 10 best days in 10 years is actually only one in 2.8 billion billion. That is still 100 times less likely than winning 2 consecutive Powerball jackpots with the same set of numbers. If I write about what I would do if I won 2 consecutive Powerball jackpots with the same numbers, nobody will take me seriously because it's meaningless to talk about impossible events. Well the stats on missing the 10 best days in 10 years fall into the same camp. They are not worth the attention given to them.
Trust me, I don't advocate timing the market. I just think this missing the 10 best days in 10 years thing is over-hyped by at least a factor of a billion. My question to Nickel and all other readers, if it's not one in 2.8 billion billion billion, or one in 2.8 billion billion, what do you think the odds are for missing the 10 best days in 10 years and how do you prove it?
3 comments:
Doesn't your analysis prove the point that started the whole thing, TFB?
If the odds are 2.8 billion billion billon to 1 to miss the 10 best days in the market over 25 years, then how good are the odds of successfully investing through market timing?
Not good, which was the whole point of the original "meaningless stat" that started the whole thing. Either way they're both just illustrations.
Ted,
If the market timing strategy is to anticipate the 10 worst days and get out right before them, then yes, this analysis shows that it won't work. It also shows that missing the 10 best days is not a reason not to time the market. I hope you can tell the subtle difference here.
Missing the 10 best days is a bad example. It's not going to happen. Let's just not use it. If we say the best days are so easy to miss because they usually happen after a selloff, market timers can come back with another strategy: stay out of the market until a big selloff, then pile on. If we say this strategy won't work, we must also admit missing the 10 best days won't happen either.
Market timing takes many shapes and forms. I don't think we can positively prove they ALL won't work. A market timing strategy doesn't have to work all the time. It only has to work during the life time of those who practice it. I don't think there is a way to identify which strategy will work at what time, but I have no proof.
I too am not an advocate of market timing, however, many fundamental investors will sit on large amounts of cash when bottom up analysis dictates that the values are not there in the market (i.e. stock prices are too high).
These investors do so in the face of these kinds of stats on missing the best days of the market over say 10 years.
Thus, I see TFB's argument as one which should embolden such fundamental investors fraught over "missing something" when in fact they are prudently protecting investors capital.
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