Why Are Market Prices Volatile?
Do not sell in May and Go Away
In the last trading day of the month of May, the S&P 500 index (an often cited representation of large-cap stocks in the U.S.) declined some -0.84% between the hours of 9:45am and 12:20pm.
And as if markets suddenly woke up after lunch, the index started an uptrend before ripping sharply higher in the last 20 minutes of the trading day, ending the day higher by +0.80%.
What of the old adage of “Sell in May and go Away”?
This was the best monthly performance for May in over a decade, closing 4.80% higher for the month than the 10 years before.
Did the earnings potential of the underlying 500 companies fundamentally change between the morning hours and the afternoon hours?
Absolutely not.
So, who is trading and moving prices?
Every single day, billions of dollars in trades occur between buyers and sellers. The daily average trading volume globally was $675.8 billion (2022). Market prices move due to a extremely large heterogeneous pool of market participants. All of whom are trading with different objectives.
Remember that aforementioned surge in the last 20 mins of the trading day? It was likely exacerbated by the fact that it was the last trading day of the month where some stock indices reconstitute. The market microstructure has been changing over the past decade, an increasing amount of trading volume is concentrated in the last 30 mins of the trading day — as passive strategies and index funds typically conduct most of their activity during that time, endeavouring to most accurately match their benchmarks. You can read about how this activity hurts investors here.
Nasdaq Economic Research has estimated that the majority of daily trading is done by intermediators or liquidity providers such as market makers and wholesalers. JPMorgan estimates that only 10% of trading volume in stocks are due to “fundamental discretionary traders” or stock pickers.¹
Investors are buying a part of an ownership in a business because they view the future prospects as brighter than today. However, there are many who buy or sell stocks without consideration of business prospects. Some examples of these participants are:
Institutions regularly buy or short a stock to hedge other investments
Index managers who buy and sell stocks to keep a tight tracking error to the benchmark
Algorithmic high frequency trading buys and sells stocks in fractions of a second, multiple times throughout the day, common with market making activity
What this means for Investors
Market pundits might give you reasons as to why a stock or market index is up or down for the day, and some will blame it on inflation expectations or geopolitical tensions, or a whole myriad of other reasons. But the reality is, nobody knows with a consistent or reliable level of accuracy on why prices have moved.
As investors, you should not be fazed by the daily fluctuation in prices because as the data shows, prices can move for all kinds of reasons, unrelated to the company’s prospects.
In the short term, prices vary for a wide host of reasons, but it is the fundamentals that set the stock prices in the long-run.
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