What the Market Does Today Tells Us Little About Tomorrow

You may have noticed something about the market this year: It's gone up. A lot.

Not just in percentage terms -- the Dow Jones (DJINDICES: ^DJI  ) is up about 11% -- but in the number of trading days that finished higher.

There have been 22,104 trading days since 1928. During that period, the market closed higher on 11,560 days, or about 52% of the time.

This year, we're pulling far away from that average. The S&P 500 has increased in 37 of the 60 trading sessions so far this year, or 62% of the time. If the trend holds for the rest of the year, 2013 will have the most number of up days in history. 

Those are the numbers. What do they tell us?

Surprisingly, very little.

Before I dug into the data, I figured a high percentage of up days would either signal high current returns, or it would be correlated with low future returns, since a reversion to the mean meant the market was due to fall on a high number of days going forward.

But neither is entirely true.

Since 1928, the percentage of days the stock market rises is positively correlated with market returns -- in other words, the more days the market rises, the higher annual returns are likely to be -- but not by much. The correlation between the two is 0.4 (zero would be no correlation, while 1 would be perfect correlation). And the number of up days in one year tells us virtually nothing at all about what returns will be in the following year (a correlation of -0.07).

Take a few examples. In 2008, the market rose on 50.6% of days -- more than half. What'd the market do? It fell 37%. In 1991, the market rose on 49.4% of days. Yet the market surged 31%.

In 1933, the market rose 49.8% of days, and finished the year up a whopping 56.8%. In 1957 it rose a staggering 62% of days -- so far the most on record -- yet finished the year down 9.3%.

There are two takeaways from this.

The obvious lesson is that the biggest market moves take place on a small minority of days. Big market rises and big market sell-offs aren't usually the result of slow, grinding moves. They tend to happen in short, sharp bursts. While the market rose on more than half of trading days in 2008, it logged 11 days of declines of 5% or larger. The majority of the year's decline occurred on a very small number of days. Which is entirely common. 

The same thing happens on the way up, which is why so many investors who bail out of the market during a crash miss the inevitable rebound. Those who sold when the Dow was at 8,000 felt great about themselves when it hit 6,000. But when ... snap ... it was back above 10,000 within months, they were left burned. Apple (NASDAQ: AAPL  ) increased more than 6,000% in the last decade, but declined on 48% of all trading days. When the big moves happen on a small number of days, timing the market means you have be precisely right, not just mostly right. And since no one can be precisely right, the results of active market-timers are entirely predictable: Most fail.

The second takeaway is a lesson in volatility. Since 1928, the S&P 500 increased from 18 to 1,560, or 86-fold. Yet the market declined on 48% of all trading days. In 1999, one of the best years ever for the market, stocks fell on just about half of all trading days. Think of it that way, and it's amazing that the financial media is so infatuated with market updates. What does it mean when the market falls? Nothing. Nothing at all. It doesn't signal a downturn, or a correction, consumers losing confidence, or traders getting nervous. It's just something markets do about every other day. 

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