Maths on the stock market

It was recently announced that young people in Flanders do very well on an international level in maths.

That's great news, as being at ease with numbers and comparisons is an important asset on the stock market, in particular. Understanding the basics of algebra and statistics not only helps us to calculate our returns, but also helps us to estimate a number of things correctly. Yet, as an observation, a whole host of things are not predicted correctly, not even by those with the best minds in maths in Flanders.

Let's take two examples, one on the topic of foreign names and one about fruit. Both delicate, but they may well prove to be useful and enlightening at the same time.

1) Moham(m)ed has been one of the five most popular baby names in Belgium for years. Is that because the Muslim community is expanding or because they traditionally choose from far fewer names than the Flemish community?

The first is the most popular answer, while the second is statistically correct. Flemish people choose from roughly ten times more customary names than people of the Muslim community. It is therefore logical that Mohamed tops the rankings.

Many years ago, we watched the Miss Belgium final on the television (because someone we knew was taking part). At the end, five contestants were left: four Flemish participants and one French-speaker. The French-speaking contestant won, even though everyone could see that one of the Flemish candidates was by far the best (but not the person we knew).

Yet why did the French-speaking contestant win? Because the viewers decided. The competition was broadcast on Flemish and Walloon television stations at the same time and Miss Belgium is seemingly very popular in the south of the country. Flemish viewers voted for their local favourite and therefore split the vote. 90% of the French-speaking viewers voted for the French-speaking finalist.

Had everyone spent a minute looking at the statistics, they could have predicted the result.

Let's return to our sensitive issue once again:

2) Suppose that 90% of cases of a given illness are caused by eating a particular type of apple. Then, imagine that 1,000 people who eat apples fall ill and that 10 million of said apples are consumed. This would mean that 0.009% of all apples make someone ill.

Here, the maths prevents us seamlessly switching from ‘a significant percentage of this type of illness is caused by this apple’ to ‘a significant number of this type of apple cause this illness’. You can probably think of other examples of errors in reasoning yourself. A little knowledge of maths and statistics prevents superficial discussions with all too premature conclusions.

Similar examples to those used above can be found in the world of stock markets.

1) The greater the number of baby names to choose from, the smaller the chance that half of the classmates years later have the same name? Perhaps. However, the more choices you have within a sector, the lesser the chance of a stock market bubble. The more biotech shares there are listed in Brussels, the easier it is for the sector to absorb the demand for shares. It's therefore best to let the dozens of biotech gems in Belgium that aren't listed to come onto the market.

2) Yet you should watch out for the same errors in reasoning as seen with the apples. Since 1929, 13 of the 40 crashes have occurred in October. So if a crash is coming, there's a 32.5% chance that it will happen in October. That's quite impressive. Remain watchful as October will be around the corner come the end of summer!

That said, October has been and gone 89 times since 1929, and 13 of them saw a stock market crash. The statistical chance that a crash will occur in October is therefore 14.6% instead of 32.5%. That's already less spectacular. What's more, in these statistics, a crash is defined as a fall in the Dow Jones of at least 10% over a few months. October often seemed to be the end of a correction that began as far back as August (last year the correction continued until December). Only in 1929, 1987 and 2008 did the market fall at least 10% in October, meaning that August and September actually experience more crashes than October.

Pierre Huylenbroeck is the author of Iedereen belegger [Everyone's an investor] and publisher of Mister Market Magazine, full of stock market insights and a real portfolio for subscribers to track, which achieves an average annual return of around 10%. More information can be found at www.mistermarket.be.