High volatility on the stock market during one session – is this a signal that we are dealing with an opportunity?

When the market plummets by 10% or more in a single day, is it an opportunity for the brave? And when it rises by 10% or more, is it a sign of an impending bull market? We've checked.

In this article you will learn:

• How often do stock exchanges experience price changes of 10% or more?
• What did historical declines in indices of -10% or more mean?
• What did index increases of +10% or more mean historically?
• When should you pay attention to stock price increases or decreases of more than 10%?
• How can day traders benefit from high volatility in a single session?

Great volatility on the stock market – opportunity or trap?

Every few months, or perhaps a dozen or so months, extraordinary trading sessions take place on the stock market, during which many investors tear their hair out, or jump in euphoria. The indices exhibit significant volatility, rising or falling by more than 10% for various reasons. It doesn't happen very often, but when it does, it evokes intense emotions.

But an extremely interesting question arises:

1. Are sessions characterized by such strong volatility a serious signal?
2. When the index drops by -10%, is it worth buying shares?
3. What to do when it grows by more than 10%?
4. Where are the indexes a dozen or so months or a few years later?
5. How should investors behave in the face of such unusual sessions?
6. Maybe they should actually… ignore them?

We tried to investigate this, but also check what scientists say about it.

It's important to remember that a 10% change in a single session is an exceptionally rare event at the index level, or even at the individual security level. Such a move is too rapid to be attributed to the slow, diffusional process of absorbing information. Such a move is highly likely to reverse immediately if triggered by a shock or misinterpretation of the information. On the other hand, such a sharp downward movement at the index level is a serious warning, as it often occurs under the influence of highly significant news.

What does the high single-session volatility on the WSE mean…

We started with the Polish stock exchange, specifically WIG indexIn the entire history of the Warsaw Stock Exchange, there have been few instances where this indicator rose or fell by more than 10% in a single session. There were two such instances.

The first case is April 21 1994when the WIG index grew by 16%This was a record single-day gain, occurring shortly after the launch of the WIG20 index. The market was in the midst of a speculative bubble that peaked around 12,859 points in March 1994, followed by a sharp correction and then a temporary rebound. Such high volatility was caused by both strong emotions and the limited number of listed companies at the time, contributing to significant fluctuations.

Okay, so was this increase a signal for investment? Twelve months later, the WIG was -29% lower, so this single-session jump was a "dead cat bounce." However, three years later, the index was 43% higher, and five years later, it was 62% higher. This shows that for long-term investors, the jump didn't really matter much, but the question is whether they survived the bear market of 1994-95.

The second incident occurred March 12, 2020This was the epicenter of the memorable coronavirus stock market crash, when indices fell by as much as -45% in just a few sessions. The WIG index fell that day. fell by -12,65%As the saying goes, "there's been bloodshed" on the trading floor, and when there's bloodshed, you have to buy, right? Well, 12 months after that terrible session, the WIG was 73% higher, three years after it was 56% higher, and five years after it was 158% higher. Yes, it turned out that it's worth buying during a crash, when others panic and there's high volatility.

When it comes to individual companies, each story is unique, and it's important to remember that. Individual company valuations can rise or fall dramatically for many different reasons—publicly known or unknown, as sometimes they're not even visible and it's difficult to properly interpret such a movement. Therefore, statistics regarding significant session movements in company prices are much less important than in the case of indices, which generally reflect what's happening across the market. It's worth being aware that the market generally tends to overreact to rumors and react lukewarmly to confirmed facts, they say. survey.

Of course, many WSE companies performed very similarly to the WIG index during the two aforementioned sessions. The coronavirus crisis is particularly interesting, as many companies' stock prices rebounded even more strongly than the index in the medium and long term. One such example is a clothing company. LPP, whose quotes on March 12, 2020 plunged by -15,2%, but 1 year later they were 67% higher, 3 years later they were 116% higher, and 60 months later they were 253% higher.

For example, one of the WIG20 companies that follows its own unique path and highly volatile sessions do not provide any rational indications or contrarian suggestions is CD Projekt – the producer of the games "The Witcher" and "Cyberpunk 2077." After the unsuccessful launch of "Cyberpunk 2077," the company experienced the two worst trading sessions in its history, with its stock price plummeting by -20% on December 17, 2020, and by -29% on December 18, 2020. Earthquake. Massacre. Was that a "buy" signal? In the 12 months following December 18, 2020, CD Projekt's stock price was 9% higher, but 36 months later, it was 32% lower. Therefore, that post-launch crash is difficult to perceive today as a contrarian signal for long-term investors.

However, it should be remembered that large drops in stock prices are often associated with an excessive, exaggerated market reaction, which can lead to a short-term trend reversal and a sharp rebound, and if there is no "fundamental" justification, this almost always happens - as research showsIn such situations, you can look for so-called contrarian arbitrage. Studies show an average stock rebound of about 2,2% in the first two trading sessions after a decline of at least -10%, which can be an interesting hint for day traders. In fact, they can extract more from dynamic one-day stock price declines than long-term investors. However, they also need to remember that factors such as  The size of the company, the presence of options on its shares or price limits modify market effects, and smaller companies are more prone to rebound, which increases potential profits, but also risk.

…and what does it suggest on the NYSE

Okay, now let's look across the pond, to the most important stock exchange in the world, the American one. And to the most important stock index in the world, the S & P 500First, let's look at the largest one-day declines in history, because they can instinctively be perceived as a contrarian signal.

Well, in its history, the S&P 500 has fallen by more than -10% four times: on October 19, 1987, on so-called Black Monday (-20,5%), October 28, 1929 (-12,3%), March 16, 2020 (-12%), and October 29, 1929 (-10,2%). And were these really contrarian signals? In the first case, a year after the disastrous session, the S&P 500 was 23% higher, three years later it was 36% higher, and five years after that it was 85% higher. Yes, here the disastrous Black Monday indeed turned out to be an opportunity. The same was true for the disastrous session following the Covid crash. A year later, the index was 66% higher, three years later it was also 66% higher, and five years after that it was 129% higher.

However, anyone who knows the history of the stock market already knows that the disastrous sessions of 1929 were not contrarian indicators. A year after them, the S&P 500 was a few percent higher, but three years later it was -68% lower, and five years after that it was as much as -51% lower. big crisis, and a major bear market hit the stock markets. It took the S&P 500 over 25 years to recover from these losses. Indeed, it didn't break through the historic highs set in 1929 until 1954.

At this point, it's worth recalling the old adage that sudden market declines are unsettling, prompting many investors to sell their stocks. However, history shows that markets have always bounced back after shocks. Therefore, the best plan for weathering market declines may be to capitalize on potential rebounds. Just look at the table below, showing the largest bear markets in the S&P 500 and the index's rates of return over the course of one, five, and 10 years following the bear market. A bear market is defined as a period from peak to trough with at least a 20% decline in the S&P 500. Of course, historical data generally doesn't say anything about the future, but it's hard to imagine that much will change in this regard in the US, unlike in other stock markets.

Okay, so what about growth sessions where S & P500 grew by more than 10%? There were six of them: March 15, 1933 (16,6%), October 30, 1929 (12,5%), October 6, 1931 (12,3%), September 21, 1932 (11,8%), October 13, 2008 (11,6%) and October 28, 2008 (10,8%). And what's interesting, usually these sessions of sudden attacks of demand were a "buy" signal. Only one of them - the one on October 30, 1929 - was a harbinger of misfortune, because a year later the index was -9% lower, 36 months later -71% lower, and 60 months later it was 56% lower.

Meanwhile, the rest of the cases were actually heralds of a bull market. And this is perhaps not surprising, as such bold bouts of demand usually signal that large institutions are rushing to buy on the stock exchange, often after a very bad period, i.e., a crash or bear market. September 21, 1932, proved to be the perfect such indicator, symbolically ending the great bear market and ushering in a multi-year bull market on Wall Street. A year later, the index was 20% higher, three years later it was 41% higher, and five years later it was a whopping 81% higher.

In fact, it's enough to recall the situation on the Warsaw Stock Exchange (GPW) in the fall of 2022. While we didn't witness a session where the WIG rose by 10%, we did see three consecutive weeks of 5% gains. This was because foreign funds ordered a "buy" order. And the WSE bull market continues to this day, almost three years in a row, interrupted only, naturally, by smaller and larger corrections.

Summary

Daily stock market volatility exceeding 10% is usually extremely interesting information, especially when it concerns indices, as it can indicate deep market problems, but it can also signal an investment opportunity. If it occurs in individual stocks (securities), it carries less value for long-term investors, but day traders should be vigilant, especially if the price has fallen without a clear fundamental reason, as a rather dynamic price recovery can be expected.