Background on the practical interest of this:
- If you could predict the direction of movement of the Dow (or of any stock) on a day-to-day basis, you could reap enormous profits.
- You don't have to be 100% accurate. As long as you can predict better than chance, you can make profits.
- So all we need is a statistical correlation between Dow activities on succeeding days.
Q: On any given day, what is the probability that the Dow moves in the same direction that it moved in the previous day?
Results: The answer depends on what time period you look at; over the last five decades, the percentage has decreased. Here are the percentages for different time periods:
- 1959-1969 57.0%
- 1969-1979 56.6%
- 1979-1989 49.9%
- 1989-1999 50.2%
- 1999-2009 46.6%
- 2005 45.2%
- 2006 49.0%
- 2007 48.2%
- 2008 42.7%
- 2009 50.0% (Jan - Feb)
- Most of the deviations from 50% (the result to be expected from pure randomness) are statistically significant; they indicate a systematic phenomenon. Analogy: If you flipped a coin 2500 times, and 46.6% of the flips were heads, that would prove that the coin was not fair. Likewise, the 46.6% statistic for 1999-2009 is not due to chance.
- The 46.6% for the past 10 years, and even more so the 42.7% for the last year, support the second theory mentioned above. However, in 1959-1979, the correlation was in the opposite direction, and from 1979-1999, there was no signifant correlation. I don't know why this should be.
- The deviations are big enough to be useful. If you could predict the Dow's movement correctly 57.3% of the time, you could be a rich man. And you would in fact have done so, if you had made a habit over the last year of always betting on opposite-direction movement.
- Unfortunately, the correlation changes from year to year. If you are only correct 51% of the time (as you would have been in 2006), that is slightly useful, but it won't make you rich.
And why has the percentage changed over the last five decades?