Do you know when the stock market has a very high probability of making money?
In around 2022, when some of the stock market indices were down big, like down almost 40% from their highest point, I invested a lot of money into the index.
Like, way more than I normally do.
I even moved amounts from low-risk funds into the index because the stock market index just had a rare high-probability opportunity.
I even shared this with Trading Rush supporters on Patreon.
When the market went up, I booked some good profits!
But here’s the thing: in around 2022, the only reason I knew I should risk way more than usual was based on previous stock market crashes I saw in my eight nine years of trading journey.
However, today, I want to analyze stock market crashes even further.
I’m going to analyze pretty much all crashes, pretty much all drawdowns on many popular stock market indices, to find what kind of drawdowns are rare.
Why is this important?
Well, you see, instead of just guessing how rare a market drawdown is, I will have data next time that directly says how rare it is.
You see, one might think that bigger drawdowns are better because we are getting a very big discount, and the price has a lot of room to move in the upward direction.
However, bigger discounts don’t happen often.
They are so rare that a person who regularly invests in the stock market index with small amounts will make more profit than someone who waits forever to get that big drawdown.
There is a saying: “Time in the market makes more money than timing the market.”
That’s why, if we know how rare a drawdown is, we can decide if we should invest more or less at that drawdown.
If 50% drawdowns happen only 1% of the time, and 20% drawdowns happen 40% of the time, then I’m probably investing most of my capital at around 20% drawdown.
I’m not waiting for that tiny chance of a 50% drawdown.
So, let’s look at the real numbers.
I analyzed these stock market indices on the one-day timeframe from the very beginning.
I counted how far down the price went in percentage from the all-time high before recovering.
Here’s what the data looks like.
Out of all the two thousand six hundred and sixty one drawdowns, around 55% of the time, the stock market indices only made around 2% or less drawdowns.
26% of the time, the drawdown was between 2 to 5%.
And 5 to 10% drawdowns only happened around 10% of the time.
That means, out of all the drawdowns, almost 92% were only 10% or smaller drawdowns.
This means that if you like to wait for a big downward price move to finally buy the stock market index, you will rarely get an opportunity.
Since the stock market index moves up in the long run, data says that buying with small amounts frequently, even at smaller drawdowns, will perform much better than waiting for a bigger than 10% drawdown and buying big only once.
But let’s say you do get a rare opportunity, like more than a 10% drawdown, which only happens around 8% of the time.
Well, things get really interesting.
The rarity increases pretty quickly.
Only around 3% of the drawdowns were more than 20%.
Only around 1.8% of the drawdowns were more than 30%.
The rarity increases even more!
Only around 0.8% of drawdowns were more than 40%.
More than 50% drawdown happened only around 0.6% of the time.
Only around 0.3% of the drawdowns were more than 60%.
Only around 0.15% of the drawdowns were more than 70%.
More than 80% drawdown only happened around 0.1% of the time.
Remember that I’m only talking about the popular stock market indices because that’s what many people like to buy, and because they have a higher probability of moving up in the long run.
Individual stocks can have different drawdown percentages.
Also, remember that I’m talking about the percentage of the total drawdowns I collected.
It’s not a drawdown probability of every day’s price move.
But what does all this data mean to you and me?
Number one: Investing in the major stock market indices regularly with small amounts will perform really well.
Number two: More than 10% drawdowns are rare.
Number three: Waiting for the big drawdown, especially the really big ones, can make less money compared to regular small amount investing in the long run.
Number four: Even though more than 50% drawdown only happened around 0.6% of the time, it can still happen.
Mentally, you have to be prepared for it in the long run.
Number five: Previously, I invested large amounts when the stock market index was down more than 30%.
I should probably move up my heavy buying threshold because that 30% or more drawdown rarely happens.
By heavy buying, I mean when I also move my trading amount into investing because that probability of making money is very, very high.
That’s all!