Stock Market Risk: A Monthly Look by John Kean
Have you ever wanted to know what the actual statistics of the month-to-month risk in the stock market are? This article looks at the question and formulates a possible reason.
Most stock market analysis focuses on whether prices will rise or fall, with much less attention given
to the question of drawdowns, or lows. Occasionally, however, even a month with a substantial stock
index gain will have a draw down that is beyond many investors' stamina levels.
Now take a look at monthly drawdowns in the Standard & Poor's 500 stock index from 1965 on. All the
data was calculated using daily close cash prices on a month-end basis. Drawdown is calculated here as
the percentage difference between a month's daily close low and the previous month-end close. As such,
some months have positive draw-downs in that their lows were higher than the preceding month's close.
Risk will be discussed from the perspective of someone who is long stocks.
Lack of endurance in the face of drawdowns is usually due to overleveraging and/or underpreparation
mentally for what could happen. In the 344 months since January 1965, 83% of those months
encountered drops to some degree from/the previous month's close. The worst case, not surprisingly,
occurred in October 1987, with a -30.14% drawdown. The average (mean) monthly drawdown over the
28.7-year period equaled -2.44%, while the median was -1.68%. In 22% of the months studied,
drawdowns equal to or worse than -4% were encountered, which might give some pause to those considering the 10 to 1 leverage available in an S&P 500 futures contract. For months that closed up from
the previous month, 19.4% still had drawdowns of -2% or worse. Keep in mind that if we were using
intraday data instead of closing data, the numbers would be considerably more negative.