Very large one-day market falls

Analysis of the behaviour of the FTSE100 Index for very large one-day falls.

Distribution of very large falls

Since 1984 there have been 189 very large one-day falls, where “very large fall” is defined as a move more than two standard deviations beyond the average daily change in the index. In other words, a very large fall is any decrease over -2.19%.

The following chart plots just these very large one-day falls.

FTSE 100 Index - very large one-day falls [1984-2014]As can be seen, although the greatest fall was in 1987, the frequency of these large falls is higher in recent years.

10 greatest one-day falls

The following table shows the ten largest one-day falls in the FTSE 100 Index since 1984.

FTSE 100 Index 10 greatest one-day fallsAfter the fall

The following chart shows how on average the index behaves in the days following a very large fall. The Y-axis is the percentage move from the close of the index on the day of the large fall. For example, by day 5 the index has risen 0.8% above the index close on the day of the large fall.

FTSE 100 average returns in the days after a large one-day fall [1984-2014]As can be seen, the index rises steadily in the days following a very large fall, and by the 20th day the market had rebounded 1.4% from the close of the day of the large fall.

See also

Other articles on large one-day moves.

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Quarterly sector reversal strategy

Do FTSE 350 sectors display a quarterly reversal behaviour that can be exploited?

In a recent article we looked at a momentum strategy that aimed to exploit the price momentum of strong sectors from one quarter to the next. This article looks at whether there is a reversal behaviour, i.e. where poor performing sectors in one quarter bounceback the following quarter.

The following chart shows the performance of a portfolio that each quarter is fully invested in one FTSE 350 sector, that being the worst performing sector of the previous quarter. Elsewhere, the portfolio is similar to that of the previous momentum portfolio: at the end of each quarter, the portfolio is liquidated and a 100% holding established in the weakest sector of the quarter just finished. This is held for three months, when the portfolio is re-balanced again. Each year there will therefore be four re-balancings. Only FTSE 350 sectors with at least three component companies are considered. The period studied was from 2003 to the first quarter 2014.

In the chart below the reversal portfolio (Weak SMS) is plotted against the FT All Share Index (FTAS) and also the previous momentum portfolio (Strong SMS) for comparison. The three series are re-based to start at 100.

Quarterly (strong and weak) sector momentum strategies [2003-2013]Notes

  1. As can be seen, the reversal strategy under-performed for the first few years and then out-performed. The volatility of the portfolio’s quarterly returns (standard deviation of 0.13) was higher than that of either the momentum  portfolio (0.12) or the FTSE All Share Index (0.07).
  2. A refinement of the strategy would be to hold the two or three worst performing sectors from the previous quarter instead of just the one (which would likely have the effect of reducing volatility).
  3. Costs were not taken into account in the study. But given that the portfolio was only traded four times a year, costs would not have had a significant impact on the overall picture.

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Large one-day price changes – paper review

How do shares prices react after a very large fall or rise in prices on one day? Do prices reverse some or all of the change quickly? Most of the academic papers on large one-day price changes address the issue of whether price reversals do occur and, if they do, the extent and duration of the reversal and in what circumstances they happen.

This article presents a brief review and listing of academic papers on large one-day price moves.

In 1985 De Bondt and Thaler (1985) proposed the overreaction hypothesis, which states that most people overreact to unexpected and dramatic news events. With respect to stocks, this overreaction can cause large one-day changes in share prices, which are then followed by a reversal.

Atkins and Edward A. Dyl (1990) found that after large one-day price changes, especially in the case of declines, the market reversed quickly, but the widening of the bid-ask spread made it difficult to exploit this. A little later Turner and Weigel (1992) found no evidence of short-term market reversals after large one-day price moves. This was followed a couple of years afterwards by the, so far, most cited work on the topic Cox and Peterson (1994), which argued that any observed short-term price reversals were due to changes in the bid-ask spread. They further observed that shares with large falls continue to perform badly beyond the short-term. In other words, the overreaction hypothesis doesn’t hold.

This was largely supported by Park (1995) a year later, who found that price reversals disappeared on the following day if the average of the bid-ask prices was used. After the following day, however, the paper did find systematic abnormal reversal returns. Wong (1997) found that prices tend to rise after large one-day advances and fall after large one-day declines (i.e. no reversals), which supported Cox and Peterson (1994) and not De Bondt and Thaler (1985).

From 2001, some papers started taking a more nuanced view of this by analysing the type of news that had caused the large price move. Pritamania and Singal (2001) found that if the news relates to earnings or analyst recommendations then the 20-day abnormal returns become much larger ranging from 3% to 4% for positive events and about -2.25% for negative events. This trend of analysis was continued by Larson and Jeff Madura (2003), who found that there was overreaction to strong price rises in the absence of news (defined as news appearing in the WSJ), but no overreaction to price rises accompanied by news.

Fehle and Zdorovtsov (2003), cut straight to the chase to analyse whether money could be made in the case of large one-day declines. They found that stocks did overreact in this situation, that the subsequent reversals could be profitably traded and that trading profits were correlated with the size of the fall. Further, following on from the above, they found that the reversals were greater for those stocks with no concurrent associated news. This was consistent with Daniel, Hirshleifer and Subrahmanyam (1998) and Hong and Stein (1999).

Sturm (2003) focused on the asymmetry of reactions: finding that large price decreases are followed by positive returns (i.e. reversal), but large price increases do not drive positive or negative abnormal returns. Ma, Tang and Hasan (2005) found a difference in behaviour between markets with strong evidence of price overreactions for Nasdaq stocks but not NYSE. This was followed by Zawadowskia, Andor and Kertész (2006) who did find significant reversal behaviour but that, while widened bid-ask spread for NYSE stocks eliminated profit potential, this was not the case for Nasdaq stocks where the bid-ask spread was unchanged offering the potential for significant short-term profits.

With respect to the UK market, Mazouz, Joseph and Joulmer (2009) found continuation, rather than reversal, behaviour after large moves. And then Gu (2013) found that the market does usually reverse its direction in the day after the large move.

INDEX (of papers listed below)

[Papers listed in reverse date order; indicates major paper.]

  1. Predictability of Big Day and Profitability Thereafter [2013]
  2. Abnormal stock returns, for the event firm and its rivals, following the event firm’s large one-day stock price drop [2011]
  3. Stock price reaction following large one-day price changes: UK evidence [2009]
  4. Is reversal of large stock-price declines caused by overreaction or information asymmetry: Evidence from stock and option markets [2009]
  5. Short-term market reaction after extreme price changes of liquid stocks [2006]
  6. The Stock Price Overreaction Effect: Evidence on Nasdaq Stocks [2005]
  7. What Drives Stock Price Behavior Following Extreme One-Day Returns [2003]
  8. Investor Confidence and Returns Following Large One-Day Price Changes [2003]
  9. Large Price Declines, News, Liquidity, and Trading Strategies: An Intraday Analysis [2003]
  10. Return predictability following large price changes and information releases [2001]
  11. A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets [1999]
  12. Investor Psychology and Security Market Under- and Overreactions [1998]
  13. Abnormal Stock Returns Following Large One-day Advances and Declines: Evidence from Asia-Pacific Markets [1997]
  14. A Market Microstructure Explanation for Predictable Variations in Stock Returns following Large Price Changes [1995]
  15. The Influence of Organized Options Trading on Stock Price Behavior following Large One-Day Stock Price Declines [1995]
  16. Stock Returns following Large One-Day Declines: Evidence on Short-Term Reversals and Longer-Term Performance [1994]
  17. Daily Stock Market Volatility: 1928–1989 [1992]
  18. The Reversal of Large Stock-Price Decreases [1991]
  19. Price Reversals, Bid-Ask Spreads, and Market Efficiency [1990]
  20. Further Evidence on Investor Overreaction and Stock Market Seasonality [1987]
  21. Does the Stock Market Overreact? [1985]

Predictability of Big Day and Profitability Thereafter
Authors [Year]: Anthony Yanxiang Gu [2013]
Journal [Citations]: Journal of Accounting and Finance , 13(5), pp63-73
Abstract: Significantly higher volume in a few day window combined with significantly higher opening may signal a big up day. Negative relationships between return and volume over a three-day window may signal the danger of a big down day. Opening prices of all the big down days are significantly higher than the day’s low and close, and opening prices of all the big up days are significantly lower than the day’s high and close. The market usually reverses its direction in the day after the big day. A strategy is developed for excess returns.
Ref: AA663

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