Even though it is hard to move more than a few feet in the blogosphere today without seeing a piece on the fateful crash of 25 years ago today, we couldn’t resist getting in on the action. Unfortunately, managed futures was nowhere close to mainstream in 1987 – CTAs were still in their infancy, as was their reputation for solid crisis-period performance (Disclaimer: past performance is not necessarily indicative of future results), so it is hard to say how managed futures as they exist today would have performed that day.

However, the futures markets were around back then, and received a fair share of the blame for the day’s trading action – particularly for the rise of portfolio insurance based on the idea of selling futures short during declines to hedge against losses in stocks. This led to a much steeper decline, for instance, in the S&P 500 futures contract than in the actual S&P 500:

That’s right, while the S&P 500 was down -20.5%, the S&P futures contract fell -28.6% (in a single day). The difference between the futures and the cash (-8% in a single day) was a 9 sigma event in and of itself, an event supposed to occur on a normal distribution curve about once in every 50 billion trading days (or about 200 million years worth of data).  And the odds of the overall move happening – were something on the order of 1 in a trillion. This is the quintessential example of a “Black Swan Event” coined by Nassim Taleb.

To put that into terms more easily understood, it’s like a 110 foot tall man walked in the door.  It simply isn’t possible on a normally distributed data set, meaning – you guessed it – we can’t use normally distributed curves for analyzing the stock market or any other market for that matter. Or for analyzing bands popularity, book sales, or wealth.  Bill Gates’ wealth is a 1000+ sigma event.

Of course – the best way to sum up the risk of another October market swoon was made many decades before Black Monday even happened.

“October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.”
                                                                                                            – Mark Twain