Japanese stocks drop -11% in the last four days. Is it time to be greedy?

Be fearful when others are greedy.  Be greedy when others are fearful. 
-Warren Buffet

The Nikkei-225 index which tracks the Japanese stock market has been hammered over the past few days as Japan as surveyed the damage from the recent earthquake and accompanying tsunami, with the index selling off more than -6% yesterday alone.  Below is a three month chart of the Nikkei index which illustrates the huge sell off the last few days.

I decided to take a look to see what has happened in the past when the Nikkei has dropped -6% or more in a single day, and then take a look to see how the market reacted after such a drop.

There were 13 instances where the Nikkei dropped 6% or more in a single day since 1984.  Below is a table showing the average return 1, 3, 5, 10, and 20 days after the drop had occurred.  The table illustrates if you had bought the market after the drop, what your return would be in the following days.  In all cases the market had an average return of at least 2.22%.  

While a sample size of 13 does not provide for statistical significance, with good risk management I believe that the odds are in favor of a profitable trade by buying the index.  I’ve picked up some June futures contracts on the Nikkei index as well as purchased April 2011 $11 call options on the iShares MSCI Japan Index ETF (ticker: EWJ)

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