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Should you try to get a head start on those who play the age-old seasonal game of loading up on stocks by the close of Oct. 31 and selling before the close on April 30? It's tempting, particularly given that the stock market is showing signs of life in recent weeks. But before you employ this "Buy on Halloween" trading strategy— the flip side of "Sell in May and Go Away"— bear in mind that the odds are strongly against you. Stock market timers in general have very poor success rates, rarely doing better over the long term than simply buying and holding.
But the proof of the pudding is in the eating: Over the last nine years, one of the two market timing services that I monitor that regularly tries to improve on the Halloween strategy by tweaking the buy and sell dates a bit has significantly increased that seasonal pattern's performance. While the other market timer has not improved on the "Buy on Halloween" strategy, it at least hasn't done appreciably worse— and has still beaten a buy-and-hold strategy.
The "Buy on Halloween" approach is also known as the "Halloween Indicator," though we confess that this expression is rather confusing. (After all, it's not an indicator, it's a seasonal trading strategy.) According to a comprehensive review of the trading strategy's historical legitimacy that appeared in the December 2002 issue of the prestigious academic journal, American Economic Review, this pattern has existed historically in 36 of 37 countries studied.
In each of those countries, average stock market returns from Halloween through May Day (the so-called winter months) were significantly higher than equity returns from May Day through Halloween (the summer months). To be sure, the Halloween Indicator is based on long-term averages, and there have been many individual years in which the overall pattern did not hold up. Several such exceptions came during the recent bear market, for example, when the winter months from November 2007 through April 2008, as well as from November 2008 through April 2009, saw the stock market buck the favorable seasonality and fall sharply.
Nevertheless, the strategy has more than made up for these and other missteps, and therefore, is in the rarefied ranks of those select few market timing systems that truly have worked over the long term. One of its biggest successes came earlier this year, when it went to cash at the beginning of May— thereby sidestepping the so-called Flash Crash and subsequent market weakness. But, not willing to leave well enough alone, two market timing services I monitor have for a number of years tried to second-guess the exact days on which a follower of this seasonal pattern should enter and exit the market. The first is the Almanac Investor newsletter, edited by Jeffrey Hirsch, and the other is Street Smart Report, edited by Sy Harding.
The Hulbert Financial Digest has data for both market timers' modifications of the Halloween Indicator back to mid-2002, more than nine years ago. The HFD calculates their returns on the assumption that, when they are invested in stocks, they earn the return of the Wilshire 5000 Index. Otherwise, they are assumed to be invested in 90-day Treasury bills.
Consider the performance of Harding's modification of the Halloween Indicator: It produced a 6.9% return (annualized) since mid-2002, or 1.9 percentage points per year more than a purely mechanical application of this seasonal pattern, and 3.2 percentage points ahead of a buy-and-hold. And it did so while, nevertheless, incurring 38% less volatility, or risk— a winning combination. [[And, it has performed even better over its full 11 year lifetime.: normxxx]] In fact, this performance is good enough to place Harding's version of the Halloween Indicator in seventh place for risk-adjusted performance since mid-2002, out of the 126 timing strategies the Hulbert Financial Digest has tracked over this period.
To be sure, Hirsch's modification of the Halloween Indicator performed less well, producing a 4.7% annualized return. Though that is less than the 5.0% return of the pure version of the Halloween Indicator, note that it is still better than buying and holding. What about this October? Both advisors rely on a short-term momentum indicator known as Moving Average Convergence Divergence (MACD) to decide when their versions of the Halloween Indicator will flash a buy signal.
To be informed when their particular interpretations of MACD actually trigger their buy signals, of course, you will need to subscribe to their services. But one way in which their MACD-based systems could trigger an early buy signal (though not the only way) would be for the market to be weak for a week or two, and then quickly jump [[but only during a particular "window of opportunity".: normxxx]]. If that happens, traders interested in getting a head start on the Halloween Indicator might want to jump back into the stock market.
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