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Profit From Seasonality

By Chris Rowe August 21, 2007 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Okay, folks, you're not gonna believe it.

In the poll that I took last week at the bottom of my "Profit From the Moving Averages" article, I asked the following:

1) What do you think the strongest month of the year is, on average, since 1991, for each of these three indices:

- S&P 500
- DOW-30

2) What three consecutive months do you think have shown the largest percentage gain for the same three indices in the same time period?

Guess what - NOBODY got it right!  Some of you came very close. 

Especially Robert who said October is the strongest for all three indices, and that November, December and January are the best three consecutive months, "because of the January effect."  But keep in mind that the January effect tends to give relative strength to small caps and riskier stocks in January, which is one reason why JANUARY is the strongest for NASDAQ since 1991.  (Great try, Robert, one month off from winning a cigar!)

Faiez was also very close with the answer 1) October, and 2) October - December.  But Faiez, I asked about each individual index, and the answers vary by index!

Stephanie, good call on knowing to sell in "May and go away" (except for NASDAQ, which is "Sell in June"), and good call on April's being a strong month, but you missed the top three consecutive months.

Peter Harmon was very right about one thing in particular.  He said that this is basic analysis, and his answer was November as the strongest month for all three indices.  Since 1991, November tied for first with December for the Dow-30.  Peter also said that the strongest months are November - January.  If you know your stuff, you probably gave the same answer for the strongest three consecutive months being November to January.  But you would have been incorrect, at least for the time frame that I was talking about.  Surprised?  This would not have been an interesting read if it were common knowledge, would it? 

Check it out:  According to Stock Trader's Almanac (sorry for the image quality) ...

Most people don't know the statistics dating back to 1991.  And since 1991, the stock market has been incredibly good to us.  The point that I wanted to make here was that most people know that November - January have typically shown significant strength.   But the fact is that this notion relates to studies that include about 60 years of data.

But a funny thing happens when people become hip to a trend.  They attempt to "front run" the trend by getting in early.  And the fact that they get in early actually changes the trend.  So what happens is the best three months end up getting pushed back a bit.  This causes January to lose its "oomph" (with the exception of the NASDAQ, whose best month is January). 

And, as Robert said, a large contributer to the strength in the NASDAQ in January is "The January Effect".  To read about the January Effect, click here.

Another major contributor to these numbers is that October was an AWFUL month in 1987 (a year not included in our calculations).  So bad that I bet some readers just lost their appetite, and threw away their breakfast simply by reading the last sentence.  I'll explain ...

In October 1987 (oops, I said it again - sorry) the Dow lost about 23% (35% from high to low), the S&P 500 lost about 22% (31% form high to low), and the NASDAQ lost 27% (37% from high to low).  I'm pretty sure the suicide rate, especially in NYC, increased substantially that year.

Then came October of 1989 (another October not included in our study).  Investors, to this day, relate the month of October to the crash of 1987.  So it's quite understandable that in October 1989, the Dow, S&P and NASDAQ lost 3%, 3.2% and 4.2% respectively.  But anyway, these two Octobers really knocked October's ranking down on the performance list averaging out monthly performance since 1950.  Data dating back to 1950 puts October near the middle, but still on the bottom half of the list!

That's another reason that I had to wake everyone up to this fact.  In fact, I should have taken a poll on what the WORST performing month was.  I mean, there are so many people that will tell you that October is the worst month of the year, even since 1991.  In fact, even when I tell people that October is the best month for S&P 500 and DOW-30 and that it's NASDAQ's SECOND best month, and even after I tell them that I did the research, and I know this for a FACT, they'll still argue with me!  If they were trading the market in October of 1987, some peoples' eyes starts to twitch when they argue this fact, so I just leave it alone.

Data dating back to 1950 show that the S&P 500's best three months were:

November   1.8%
December   1.7%
January       1.4%

Obviously, the best three consecutive months are November - January.  I guess I should mention that April came in at a close 4th with 1.3%, and that April, these days, is still a strong performer.

Since 1950, the Dow-30's best three are:

April           1.8%
December  1.7%
November  1.7%

And with January coming in 4th with 1.3%, that makes the best consecutive three since 1950, again, November - January.

The NASDAQ was created in 1971.  Since 1971, the best three performing months are:

January      3.7%
November  2.2%
December  2.0%

Good try, everyone.  And don't forget, as Gerald Appel says: When trading stocks, you must take a synergistic approach. 

You should base your decisions on several different indicators and factors.  Use one to confirm the other.  Don't think that you are guaranteed to make money on the "coming bull market in October" or anything like that. 

Seasonal cycles are important to understand and keep in mind.  If you think the market isn't done correcting, also consider that September is known as the weakest month, and that October is pretty much the strongest.  Also consider the fact that the Pre-Election year (that's this year, folks) is BY FAR the best performing year out of the four-year cycle.  But anything can happen, and seasonal cycles don't always pan out.  (Last September was one of the strongest months in 2006.)

I hope that I made or saved someone some cash today.