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Standard deviation and shorting Goldman Sachs (GS)

Sid Soni, May 3, 2010

On the news of the SEC lawsuit against Goldman Sachs, I  shorted shares of GS in anticipation of further declines.  About a week later, Goldman's earnings forecasts were downgraded, resulting in a sudden 10% drop. 

A steep drop for a Wall St. darling raised the question: Do I take profits (short term "reversion to the mean") or hold out for further declines?

One consideration was to calculate how rare a 10% single day drop for GS is.  I downloaded 3 years of market data, and ran it through Excel's Analysis Toolpack
( =2%, σ=3%) Based on this standard deviation, a Z-score of +2.98 placed it in the 99.86th percentile of its typical daily volatility.

Since it was extraordinarily rare for GS to fall this much in a single day, I closed out the position anticipating a (short-term) rebound.  The position was initiated qualitatively, but closed quantitatively.

I decided to bring this real-life situation into the classroom.  First, I showed students how to replicate the research.  Next, they applied the methodology
on several other data sets, in order to further investigate the efficacy of this methodology.
This lesson was an opportunity to:

  • Use statistics to enable data driven decision-making. 
  • Discuss impacts of business ethics (or lack thereof, in Goldman's case) and field incidental questions about stocks, investing, and personal finance.
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