What happens after a big fall in share prices? There are two possibilities. One is that the market bounces back, because a big fall increases risk, and higher risk means higher expected returns. The other is that "contagion" occurs - nervousness feeds on itself.
I looked at the 30 worst weeks for the All-share in the last nine years - weeks when the market fell 3.3% or more, and asked: what happened the following week?
On average, the market actually fell in those weeks, by 0.24%. That's worse - though not statistically significantly so - than the average 0.06% rise for all weeks since July 1998.
This suggests the contagion effect offsets the lower prices = higher expected returns mechanism.
Big falls do, however, raise the volatility of subsequent returns, and cause them to become slightly positively skewed. So, recent history suggests the odds are (slightly) against the market bouncing back next week.
What about your advice to hold shares over the winter but not the summer?
Posted by: dearieme | July 27, 2007 at 10:59 AM
The FTSE 350 is 3.1% down since April 30. So that advice looks OK now. But then, most advice that you ignore looks good in hindsight. And volatility is such that this can easily be recouped: it's only yesterday's move.
Posted by: chris | July 27, 2007 at 02:34 PM