How often has the Nifty crashed? A reality check on volatility

Published: May 31, 2019 at 11:27 am

Last Updated on

How often has the Nifty crashed? Has it crashed once it reaches an all-time high? When has the Nifty crashed in the past? Is it possible to use this information to predict when it will crash in the future? Let us try and find answers to these questions using Nifty closing price history from July 1990 and PE, PB, Div

As a first step, we shall find out how often has Nifty traded at an all-time high. Out of a total of 6993 trading days,  the Nifty has been at an all-time high for 2836 days or 41% of the time. So this is a fairly common event and nothing to worry about. In other words, it is time to stop asking, the market has high an all-time high, can I invest now?

How often has the Nifty crashed?

Next, we shall look at the drawdown.  This is a measure of how much the NIfty has fallen from an all-time high. You can learn more about this in this video. The Nifty closing price and drawdown is shown below the video.

Nifty Closing Price and Draw Down

When the red line is at its maximum of 0%, the market is at an all-time high. Notice the biggest fall has been during the 2008 crash. This is known as maximum drawdown. A fall of 5$% from a peak is known as a 5% drawdown event.

Now out of the  6993 trading days

  • More than 5% drawdown events have occurred 5110 times or 73%
  • More than 10% drawdown events have occurred 4156 times or 59%
  • More than 15% drawdown events have occurred 3453 times or 49%
  • More than 20% drawdown events have occurred 2723 times of 39%
  • More than 30% drawdown events have occurred 1540 times or 22%
  • More than 40% drawdown events have occurred 583 times of 8%
  • More than 50% drawdown events have occurred 124 times or 2%
  • More than 60% drawdown events have occurred 0 times

Notice that even 15% of drawdown events are fairly common occurring almost half the number of the trading days!! We need to get used to these! That is the reality check I am referring to. This is not a future probability but a past statistic. It is atrocious how many writes confuse the two. Notice that the big drop between 20% to 30% events. This is probably why more than a 20% fall is classified as a market crash.

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  • 80% of 5% drawdown events become 10% drawdown events (4156/5110)
  • 80% of 10% drawdown events become 15% drawdown events
  • 78% of 15% drawdown events become 20% drawdown events

Or,

  • 80% of 5% drawdown events become 10% drawdown events (4156/5110)
  • 67% of 5% drawdown events become 15% drawdown events (3453/5110)
  • 53% of 5% drawdown events become 20% drawdown events
  • 30% of 5% drawdown events become 30% drawdown events

So a 5% fall becoming a 20% fall has still been a coin toss in the past. Suppose we wanted to time the market, then a 5% trigger could result in a lot of false alarms. A 15% drawdown event could be a reasonable compromise between too soon and too late.  About 45% (1540/3453) of 15% events have gone to become 30% events. So that is close to a coin-toss (50% probability).

Ideally, if we could try and predict (only try) which of those 15% falls would go on to become 30% falls, it would be great. A similar claim (with no details) is being made here. That is possible only if we had an additional, preferably independent indicator. Now that is the trouble.

Before we proceed, let us take stock and answer some of the questions posed upfront.

  • How often has the Nifty crashed? Defining 20% drawdown as a crash, it has breached the -20% mark from 0%10 times.  You can count this from the above picture. There is no pattern to state a frequency. It has occured in less than a year, once in a year, 2,3,4 years! Let me know if I am wrong. I am not trying to point out that these are rare events!!
  • Has it crashed once it reaches an all-time high? Clearly, the answer is no as the Nifty all-time highs more often lead to newer highs (momentum!!)
  • When has the Nifty crashed in the past? Naturally, I am referring to the date here. We would like to know if there has been a red flag in any other indicator to support the movement of the Nifty (say a 15% event). Easier asked than answered. Let us see.
  • Is it possible to use this information to predict when it will crash in the future? Even if we could find a pattern, reliability in the future can be tricky as we do not have enough history anyway.

Using the Nifty Valuation Tool to Find out if the stock market is expensive or cheap in multiple ways, it is pretty tempting to compare the PE with drawdown events. However, notice that big crashes can occur at low PE (arrow) and so call high PE (two standard deviations above 10Y average) need not lead to “crashes”. PE timing fans never seem to understand this although it is possible to execute Market Timing with Index PE Ratio (Tactical Asset Allocation Backtest Part 1). The correlation with Nifty PB and Dividend Yield is even worse!

Nifty PE and Nifty DrawdownThe answer to, can we find support to when Nifty falls 15% from a peak is elusive (at least to me). I shall try and find support from other types of indicators (fiscal deficit, oil price, 10Y bond yield etc. This is not an easy problem and I am not easily satisfied. To be continued.

Watch: Should I be worried about all-time highs?

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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2 Comments

  1. Thanks for the very useful analysis. Means that we have to plan for a contingency fall of at least 20% for any future event where we need money though this might not happen in a single day.

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