Black Monday 1987 and the 100 foot tall man

Even though it is hard to move more than a few feet in the blogosphere today without seeing a piece on the fateful crash of 25 years ago today, we couldn’t resist getting in on the action. Unfortunately, managed futures was nowhere close to mainstream in 1987 – CTAs were still in their infancy, as was their reputation for solid crisis-period performance (Disclaimer: past performance is not necessarily indicative of future results), so it is hard to say how managed futures as they exist today would have performed that day.

However, the futures markets were around back then, and received a fair share of the blame for the day’s trading action – particularly for the rise of portfolio insurance based on the idea of selling futures short during declines to hedge against losses in stocks. This led to a much steeper decline, for instance, in the S&P 500 futures contract than in the actual S&P 500:

That’s right, while the S&P 500 was down -20.5%, the S&P futures contract fell -28.6% (in a single day). The difference between the futures and the cash (-8% in a single day) was a 9 sigma event in and of itself, an event supposed to occur on a normal distribution curve about once in every 50 billion trading days (or about 200 million years worth of data).  And the odds of the overall move happening – were something on the order of 1 in a trillion. This is the quintessential example of a “Black Swan Event” coined by Nassim Taleb.

To put that into terms more easily understood, it’s like a 110 foot tall man walked in the door.  It simply isn’t possible on a normally distributed data set, meaning – you guessed it – we can’t use normally distributed curves for analyzing the stock market or any other market for that matter. Or for analyzing bands popularity, book sales, or wealth.  Bill Gates’ wealth is a 1000+ sigma event.

Of course – the best way to sum up the risk of another October market swoon was made many decades before Black Monday even happened.

“October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.”
                                                                                                            – Mark Twain

One comment

  1. Your blog is one of my favorites. However, I do not agree with everything I read. Regarding this post, I think that traders and investors with prudent risk management and sufficient capitalization should not pay attention to rare events, distributions of returns with fat tails and other such statistical details. Since my response is too long to repeat here, I made a post in my blog here: http://t.co/OhjfEKAW

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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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