Using Trading Patterns to Predict Your Future
Michael Bennett, Optionetics.com
June 26, 2001
June 26, 2001
Assuming we start from here and resume historically normal trading patterns, there is an abundance of predictable opportunities on the horizon that can be taken advantage of with a relatively high probability of success. Most investors believe that there is no predictability in market direction. Facetiously, I guess this means that markets will go up, down or sideways! So I have a one in three chance of getting it right. This is actually only true if your glass of water is half empty. Since mine is half full, let’s look into some good times of the year to be trading the market so perhaps we can bring the ratio up a bit.
To start with, there’s an old saying, “As goes January, so goes the rest of the year.” What this means is that for the last 51 years, the S&P 500 ($SPX) index performance for the month of January has been a reliable predictor of market direction for the remainder of the year. The index has been up or down for the year based on whether it rose or fell in the month of January 46 out of 51 times since 1950—a pattern with more than 90% accuracy! Even last year when the index fell more than 5% in January, we had the now infamous “Tech Wreck.” Though the index itself wasn’t down by much, it was nevertheless an accurate prediction. It will be interesting to see if this year’s rise in January will bring us good tidings by the year’s end. We’ll have to watch the 1320 level to see if we close above it by December 31. This ought to be fun!
If you’re impatient and don’t want to wait the entire month of January, according to the 2000 Stock Trader’s Almanac, any gains in the first five days of January since 1950 have led to year end gains for the S&P with the exception of 4 years—3 of which were war-related.
So what are the best months to trade? Well, apparently $10,000 invested in the S&P since 1950 for the months of November to April have produced over a 3000% return, whereas the opposite 6-month period from May through October have netted a paltry 110%. I personally know of a few traders who will only trade during the winter months after October. Why is this? The biggest reason is year-end tax selling where the fund managers who move the biggest money will dump as much of their losers to take losses on their books in order to compensate for any gains. Also, most managers do not want to have too much weight in the underperforming stocks. When investors are making year-end decisions about where to put tax refunds and year end bonuses, these fund managers want their portfolios to shine with only the best. Wouldn’t you? Take into account that the summer months tend to be light and many people are taking vacations, you have a scenario known as the “summer doldrums”.
Now I haven’t done any studies on this, but is would be interesting to see how a combination of trading bullish LEAP strategies during the months of November to April with bearish LEAP calendar spreads during May through October would turn out. The reason I say calendar spreads during this time is that the incremental gain over the last 50 years during those months shows that that period of the year is not so much bullish or bearish as it is flat.
As this year has been a most unpredictable one, you may want to continue to monitor the months of July-August. According to the Almanac, it used to be since the early 1900’s that the best month to invest in the stock market was August when 35% of the nation’s population was farming. This is the harvest month and lots of cash was invested as a result. Now that only 2% of our population farms, it makes sense that this month would be the worst performing month for the Dow Industrials ($INDU) during the calendar year. Not only is it the worst month for the Dow, but when there’s bad news, the drops are compounded. Take 1998 for example, when the Dow fell 15% during the month of August in the midst of a global financial crisis.
Of course, nothing is set in stone; there’s very little that can be counted on by any means. But the idea here is to find predictable patterns of price behavior during the year and make a plan on how to trade during those times. If you can learn to combine such patterns with hedge strategies using options as a primary investment vehicle, the returns could be limitless.
Michael Bennett
Staff Writer and Trading Strategist
Optionetics.com
mbennett@optionetics.com
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