How to use historical stock market data to build your investing intuition, and move one step closer to becoming an investing superhero
On Monday, October 17, 1987, the S&P 500 dropped a little over 20%. Going back to 1950, this was the single worst one-day drop in the stock market. It showed and taught a lot then, and it can still teach market participants and investors today if they are willing to listen.
Historical financial data can be magical - it can help you travel into the past and see the forests from the trees. By listening to historical data, we can more easily understand that a single-day drop of 20% in an index such as the S&P 500 is possible. By knowing that a 20% stock market drop is possible -- and by seeing the number present itself to us in the data -- we can better understand the risks we face by investing and participating in the financial world.
How do we know whats or of stock market drops are possible?
What exactly does possible mean in the context of investing and considering severe market declines? Sure, we know it's "possible" for the S&P 500 to drop by this amount or that amount. But until you ground your understanding in some historical data, you're not going understand this possibility at a deep level.
Observing the S&P 500's daily price movements will help you learn what sort of severe drops are possible for your portfolio
First, a quick note on using the S&P 500: The S&P 500 is a great place to start because it's a reasonable proxy for the market. The S&P 500 surely doesn't represent the entire market of equities, financial assets, and let alone of all assets; but, it's a reasonable and easily-manipulatable proxy for "the market."
If we care about how bad things can get in a single day (eg. an extremely severe yet plausible one day decline in your portfolio), we'll want to look at daily price data. This type of data is readily available online. There's a lot of free data, but you'll have to pay to access longer time horizons or more esoteric data.
Below, we have S&P 500 data April 3, 1950 to September 6, 2019. This represents an almost 70-year time horizon, a bit less than the expected lifespan of a person today. You can see this in the screenshots below (bottom and top of the table shown; table ordered earliest to latest).
The data has three columns - one shows the date, the other the closing price of the S&P 500 on that date, and the last column is the day-over-day change int he S&P 500 stated as a percent. The day-over-day change is easy to calculate - it's merely the one day change divided by the previous day's closing price. Declared as a formula, it is: [Day 2 - Day 1]/Day 1
This is called the arithmetic return. More complex return types -- namely the geometric return -- exist, but they are outside the scope of this discussion. The simple arithmetic return above is sufficient for our purposes.
Observing financial market data can teach you a lot and help to build a bit of market-related intuition
Just observing stock market data like this can be useful. Exploring data visually without graphing it can give us some interesting and potentially-valuable preliminary insights. This is especially true for people who haven't done this sort of data analysis before. For example, we can observe that in the very beginning of our data set (the first few days of April 1950), the S&P 500 was around $18. This is in sharp contrast to the almost $3000 S&P 500 level we observe below for September 2019. This plainly shows us that there has been some dramatic growth over the last 70 years in absolute metrics.
Although we can see some things by observing the financial data, it's hard to determine summary statistics about the S&P 500 data set visually. Stats like mean, median, minimum, and maximum are hard to see because all of the data needs to be taken into account. Taking all of the data into account can't easily be done relying on the human mind - it's just not what it's made to do. The data set has almost 17,500 rows - that's simply too much to comprehend without the use of computing devices/methods (or without a considerable amount of time to devote to this endeavor). Luckily, such devices/methods are easily available for free (eg. Google Sheets) or cheap (eg. Microsoft Excel) in the form of software. More complex options are available that are both free and paid (eg. R, Matlab, Tableau, etc.). Something like Microsoft Excel would be enough for the vast majority of use cases, however.
Finding the minimum, or the worst stock market day over the last 70 years
Some relatively easy functions can be used in Excel -- the tool of choice for most finance people -- to get some stats on the data. In the screenshot below, you can see the average, the max, and the min. The min is what we care about most here - it represents the lowest day-over-day S&P 500 change; it represents the most severe single-day drop in the S&P 500 over the last 70 years.
We can see that the worst drop is -20.47%. That means that in one single day, the stock market effectively dropped by over 20%.
Black Monday - an over 20% one day drop in the stock market
We can see the drop occurred on Monday, October 19, 1987, by examing our data set in greater detail. By filtering the data from largest to smallest, we can see what date corresponds to the worst stock market drop. Once we have the date, we can observe what happened around it in the days before and after Black Monday, which is what Monday, October 19, 1987is called in the financial industry.
The image below is the copied and pasted data from around Black Monday. It's interesting and useful to observe what happened around that time. We can see in the 10 days around Black Monday, 7 out of 10 days were losing days. We can also combine the losses to see what the cumulative loss over the 10-day period would have been. We can see that it's even worse - over the 10 days, the stock market dropped over 26%.
That means you could wake up one day over the course of your investing life and see that your portfolio is down 20% in a single day. That event would be tough to deal with - you'd be in for a very rough day and rough week. It would take some time to recover from the loss, but recovery would definitely be possible. A mistake, however, would be to panic and deviate form your long term investment strategy for no real reason beyond the fact that you're freaked out.
Use this knowledge to avoid panic sales and other forms of freaking out during the next inevitable stock market disaster
We all get freaked out in investing - it's your money that's on the line, and you don't want to lose it. Even small drops can seem bad. Even times where there's no movement could be perceived as bad if you were anticipating gains. You can't let these investing difficulties make you make investing mistakes, however. You've got to do your best to maintain a long-term perspective on investing. Something that helps us do that is exercises like the one we just went through. Looking at historical market data, understanding how the markets have moved over time, and understanding how markets may tend to move int he future are all essential things that will buffer you from foolish investing mistakes made out of fear.
If you'd like to explore the Excel file form which the above screenshots originated, you can download the file here. You'll be able to copy and paste the S&P 500 data to do your own data analysis work, like finding the maximum one-day increase.
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