Sell in May and go away is not strictly correct, there is some truth to this age old saying in the markets. By studying the S&P 500 from 1980 you will see that the market usually rallies from late January until early June.
From early June until late August the market tends to consolidate these gains chopping up and down during this time. It does on average move slightly higher before falling from late August through to a low in late October. And from here the market then rallies strongly higher through to the end of the year.
This pattern is known as a seasonal pattern and was first discovered in the commodity markets, with the first published work written by Larry Williams.
Larry Williams discovered that when a crop was harvested there was an abundance of supply of that crop so prices tended to drop and as time passed and the commodity was not being harvested the price tended to rise.
This fundamentally makes sense that the commodity is cheaper when it is available in abundance and gets more expensive when it is scarce. With crops the growing cycle creates a natural seasonal tendency.
But the same analysis can be applied to other markets where seasonal patterns also play out, but the reasons are not as obvious as they are for commodities. Studying the S&P 500 since 1980 the following seasonal chart is created.
It can be seen that the market is higher from January through to the end of May and from the end of October to December. Remember seasonal tendencies are averages it does not mean that the market will do this every year.
February 2009 was a good example of this where the market fell sharply even though the seasonal bias was for the market to climb higher during this time. But studying history it is possible to gain an understanding of how often this pattern is likely to play out.
At the start of the year there is a slight upward bias, but nothing really spectacular here. From late January through to June however the market has a strong bias to rise with a 70% probability of being higher and returning 2.33 times the profit to the losses. This could very easily be the basis of a profitable trading strategy.
The market then reverts to a slight upward bias until the end of August. From end of August until the end of October is the weakest time of the year with the low coming in on the 27th October. And the year finishes with a flourish delivering its best performance of the year. With an 81% probability of the market climbing higher, you certainly want to be on the right side of this move.
So seasonal patterns can be used to assist your investing and profit from the market. While not a guarantee there are certainly times of the year where it is better to be a buyer or a seller. Is it Sell in May, I would suggest wait until the 6th June.
Jeff Cartridge
LearnCFDs.com