Yesterday there was reference to the fact that the S&P 500 hasn’t had 5% drawdown since October 2020. This is correct but still 2021 won’t beat 2017.
The chart below shows this year won’t be as good as 2017 in terms of volatility and drawdown.
Maximum drawdown so far this year is -4.23% versus just -2.8% in 2017.
Drawdown is a random variable with power law distribution. The moments may be unknown. Below is a chart with some interesting statistics for S&P 500 since 1941.
Statistics about the available sample (not of the distribution):
|Max. drawdown > 5%||53.1% of the time|
|Max. drawdown > 10%||37.1% of the time|
|Max. drawdown > 25%||9.8% of the time|
Therefore, based on the above sample statistics, it’s little less than a toss of fair coin (46.9%) for maximum drawdown to be less than 5%.
Maximum drawdown has exceeded three standard deviations of the available sample (-41.2%) in 1974, 2003 and 2009.
There will be probably another occasion in the future with maximum drawdown exceeding three standard deviations. In the meantime, it’s also highly probably most of those who constantly expect it will be out of the game.
More importantly, large drawdown levels present unique opportunities for martingale risk management strategies (averaging lower) for those who have a longer-term view of investing.
In fact, the counter-argument is that low volatility and lack of large drawdowns hurt participants that can manage risk in favor of those who cannot, who panic and sell after a correction. But since the latter are the majority, maybe volatility must remain low.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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