Outlier Detection

Outliers are points that lie far away from other values.

They are usually considered to be a 3 standard deviation move from the mean (assuming a normal distribution).

The little m, or mu, as it is called, represents the average for the data set.


However, stock prices don’t tend to follow this normal distribution, or bell curve.

They tend to skew down, as large losses on average (believe it or not!) occur  more frequently in the market.

Range Daily Change in SP500 Expected to Fall Outside Has Actually Fallen Outside
1 st dev +/-1% 1 every 3 days 1 every 4 days
2 st dev +/-2% 1 day a month Twice a month
3 st dev +/-3% 1 day a year 6 days a year
4 st dev +/-4% 1 day every 40 years 76 times over the past 40 years
5 st dev +/-5% 1 day every 5000 years 37 times over the past 40 years

A 1 standard deviation move coincides with a 1% change in the market, up or down. So if the market goes up 1%, that’s a one standard deviation move to the upside.

However, looking at the table, we can see that this pattern occurs less than expected at the smaller moves. But the further out we go, to the larger standard deviations, the more often the move happens.

The normal distribution applies to the market at the smaller standard deviations, but less so as we move out. (The moves that aren’t supposed to happen, happen- not a normal distribution!)

Tastytrade.com stated that 95% of 45 day periods in the SP 500 fall between -25% and +16% moves. 99% of all cycles are in this range. So what’s going on in the market right now isn’t that unusual- it’s weird, but the market has bounced in between these values for a while now.

So, financial outliers occur more often than theory suggests, but they are still not super profitable plays (you might get a nickel or so in credit)

But when large market moves do happen, options get overpriced due to fear- and that’s when we move in!

It’s a cycle. Just remember, what goes up, must come down.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: