I presented a long term view about expected return for SENSEX. I mentioned that the compounded expected return was 12.1%, while the arithmetic average was 16% per year.

Today, I am discussing the short term perspective using a NIFTY index. Similar calculations can also be done using SENSEX, but I believe NIFTY is a better representation. I calculated daily returns, weekly returns, and monthly returns for NIFTY from August 2002 to May 2009. In all three cases I have used average closing value on a given day, given week, and given month. The table below shows the summary for these results.

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You can see that how the chances of negative returns tend to reduce when the duration of trade increases.

• For the time period used in this calculation, 47% of the time daily returns are negative, 44% of the time daily returns are less than 2%, and only 9% of the time daily returns are more than 2%.
• However, when we look on monthly basis, negative returns reduce to 32% of the time, while 59% of the time monthly returns are more than 2%.

In addition, more enterprising and inquisitive readers can look at the graphical plots below in which I plotted:

• Histogram to show the distribution of the data; and
  
• Scatter diagram to show the randomness over a period of time

These plots also show a similar trend as summarized in table above.

• I am actually surprised that the histogram shows a very narrow distribution for daily returns. I am also very confident that this curve will pass statistical hypothesis testing to show it is statistically a normal distribution. However, I want to keep it simple here for ease of understanding.
• The histogram for weekly returns is skewing towards ‘less than 2% returns’.
• Monthly returns do not have any distribution. I do not know whether lack of distribution is good or bad. However, you can observe that the majority of the time there are positive returns i.e. occurrence of 2% or more returns is quite often.

Summary…

The purpose of my sharing these results is to bring out the expected returns from the market based on daily, weekly, and/or monthly trades. These are based on NIFTY index. These results can be interpreted in multiple ways because each individual has its own way at looking at number (glass can be half full or half empty).

Every individual is free to expect more than 2% returns on daily trades. However, you must realize that there is only 9% chance that you will get your more than 2% return. In addition, there is 47% chance that you returns are likely to be negative. If you are willing to take that risk, then go for it.

Another individual can target for more than 2% returns, but decides to use monthly trading window. This way the chances of getting your desired returns are increased to 59% (instead of only 9% chance using daily trades).

Many readers and users alike may say that with proper stock picks individual stocks can return 10%, 20% or even more. I agree with them, and I do not deny the possibility of such high returns in short time period. However, the point I am making here is what are the “chances” of such high returns? Sure, individual stock picks can have high returns, but chances become very low. For example, individuals can surely attempt to target 5% or more returns on their daily or weekly trades. But then, they should accept the fact that chances are less than 1% and they are taking more risk than the market itself.

Everybody talks about high risk, low risk, or medium risk. In absence of a quantifiable number, it becomes very subjective to make a judgement call. There are a lack of guidelines which individual investors like you or me can use to make a judgement call. Just saying it is high risk, does not help us. It is very subjective.  Therefore, if an individual is interested in trading, the emplirical numbers I presented here can be used as a guide to put certain level of expectations. It helps you understand your risk-return scenarios. It helps you quantify the “risk”.

Disclaimer: These are empirical statistical derivations and should be only used as helpful guidelines. They only demostrate historical perspective. These are not trading rules. These derivations do not consider any fundamental basis for expected returns.

This article was written by TIP Guy of TIPBlog.in

Tags: Expected Return, Nifty

This entry was posted on Thursday, June 25th, 2009 at 8:14 am and is filed under Market updates, MoneyVidya Blogger Network. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.