Since You AskedQ&A
Since You AskedConfused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.
SEASONALITY
I was chatting with a group of traders the other day while visiting friends in Chicago. We discussed all sorts of things, and after a couple of beers, the conversations focused on a couple of distinct topics. The first one was something I have not heard of before — seasonality. At first I assumed that they were perhaps referring to the Christmas season for retail stocks, or even the travel season for the leisure industries like hotels and airlines. After a few minutes I was told that seasonality occurs every month in the markets, and many times, twice a month. Can you help me understand what this phenomenon is? Anything you can share will be appreciated.—Jacko6719
I’m glad that you brought this up. There are several aspects to what we call seasonality. I think your buddies were speaking of monthly seasonality (sometimes called turn of the month). Stocks tend to go up the last couple of days of each month through the first couple of days of the next. Some attribute this effect to the money flows in mutual funds. However, since so much mutual fund money has been redirected in recent years to exchange traded funds (ETFs), we simply know that more often than not, these days tend to be up days.
You got me thinking about other seasonal events that may be of interest to readers. Before I get into these other time frames, let me say that professional traders don’t just sit and wait for all the stars to align, or for their charts to quantify buy & sell decisions. Many of us accept that when something happens more often than not, we should use it in our decision-making process. For example, if you find yourself getting net short the market toward the end of any month, perhaps you should flatten out or balance out your positions. Our traders tend to be market neutral, but they can still profit from taking advantage of entries & exits based on the calendar dates. I’ve had traders who have negotiated to use more of our firm’s capital to play monthly seasonality.
There are several time frames to consider when making your trading or investing decisions.Let’s talk about other time frames that might be of interest. Window dressing comes to mind. This tends to be quarterly, but it can also add to the monthly seasonality. It occurs because mutual funds and other investment groups and hedge funds don’t want to send out a quarterly report without having the top-performing stocks in their portfolio. Thus, we see the high-flying stocks going even higher during these periods.
Several of our traders take advantage of what we call year-enders. The basics are simple: We buy a group of those stocks that are classified as underperforming before the calendar year-end. In late November or early December, many investors sell their losing positions to create tax losses, but they are still hopeful that those same stocks will bounce back soon. Since the wash sale rule prevents them from buying back these stocks for 30 days, they tend to buy them back in January. This has worked well for decades. Here is the definition of the wash sale:
The January effect is the followthrough of the year-enders. For the same reasons having to do with repurchasing tax-sale stocks, January tends to boost the overall markets.
Now to the effects you mentioned in your question. If you look at historical data, you’ll notice that we have pre-holiday rallies more often than not. The good old “Santa Claus rally” may not be a politically correct description, but it often works nonetheless. In addition, many traders believe that they shouldn’t sell on Mondays or Fridays (I don’t agree with this one).
Thus, when giving consideration to seasonality, there are several time frames to consider when trading or investing. These seasonal tendencies should not be the primary motivation to buy or sell, but they should be included in a trader’s decision-making process. Perhaps even the self-fulfilling prophecy comes into play, as with many things related to trading the markets. I strongly suggest that all traders take the time to do the research and see for themselves how accurate these effects have been over the last 75 years or so.