Rosetta Genomics and Expecting the Unexpected

Yesterday morning the Twitterverse was abuzz over biotech stock Rosetta Genomics (ROSG) after it leaped 74% from its opening price of $13.45 to a high of $23.43 in less than two hours. At times like this that we like to remind ourselves of two things: first, that dramatic moves in markets can just as easily bring ruin as riches (remember Long-Term Capital Management, Amaranth Advisors, etc), and second, that market returns are not normally distributed.

This doesn’t just apply to small biotech firms, either – even the returns of big indices like the S&P 500 aren’t normally distributed. To show you what we mean, we charted the distribution of daily changes in the S&P 500, and overlaid it with an equivalent number of randomly-generated returns along a standard normal distribution to show what it might look like if returns were normally distributed:

Click to embiggen.

Disclaimer: past performance is not necessarily indicative of future results.

There are a couple of things of note here: first, the S&P 500 returns are far more clustered around the mean than in our normal distribution. In other words, more days are clustered close to 0% (so much so that we cut off the bar for the 0% days – it went all the way up to 169). In fact, there are actually fewer days in the 1%-2% range than we would expect if returns were normally distributed. More importantly, see all those data points scattered off to the sides? Yeah, we know they are small and hard to see, but they are there – those little blue bumps along the bottom axis are what we call outliers. A normal distribution should have virtually zero (0.3%) of its data points fall beyond 3 standard distributions of the mean, thus the flat orange line on either side of the graph; but for the S&P 500 it’s almost three times higher – about 1.4%.

Why does all this matter? Well, sometimes big financial institutions use probability to determine their risk (like JPMorgan’s use of Value at Risk, a measure of risk that tries to determine the likelihood that the trading loss of a given period will exceed a certain level). When financial risk calculations start relying too heavily on these kinds of statistical assumptions, those little blue outlying bumps can turn into billions worth of losses – or worse.

Oh, and by the way, we had to cut off the chart at +/-5% to make it readable, even though doing so cut off 41 data points (that’s right, there’ve been 41 days in which the daily gain or loss in the S&P 500 was larger than +/-5%). As always, we must tip our hat to Nassim Taleb and his book Black Swan, which delves into this subject in much greater detail (and is a must-read in our opinion). Remember that finance lies in Extremistan, where it pays to expect the unexpected.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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