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5 Ways to Profit From Seasonality - And Boost Your Stock Portfolio!
Kyle Sarwal
July, 2011
Although the success of your stock portfolio is ultimately based on the stocks you pick and your timing within each individual stock's rise and fall, there are also larger undercurrents that can impact the entire market. We are talking about seasonality - not to be confused with market timing. Market timing refers to picking the tops and bottoms of short-term price patterns within the market. Seasonality, on the other hand, refers to using historical seasonal price patterns to anticipate how the market will react and then proactively investing based on that knowledge.
1. Year End & January Effect
As we near the end of December we usually see a dip in the small cap stocks as investors sell losing stocks in order to claim capital losses. This mad dash to sell off stocks before the end of the year is then followed with excited buying at the beginning of January as investors make their return to equity markets.
If you have losing stocks and are looking to record a tax loss, it's best to start thinking of selling towards November / early December, rather than waiting until the very end of December, when stocks are over sold. By beating the market to the selloff, you'll be out before the mass sell-off sends prices even lower. Vice versa, if you are looking to buy small caps, the end of December is often a good time to do so before the market picks up again in January, hence why we term it the "Year End & January Effect"
2. Turn of the Month
There is a tendency for stocks to rise at the beginning of each month and then dip during the middle of the month. In particular, the last day and first two days of the month tend to be more bullish. New money being directed toward mutual funds plays a large role in this effect. As a result, if you have a monthly investment plan, contributing to your portfolio in the middle of the month may prove more lucrative than investing at the beginning of each month. A great entry point for some investments occurs at the Turn of the Month.
3. Mondays and Holidays
Although I did say "5 Tips", I like to under-promise and over-deliver. Here are two tips bundled into one:
Firstly, stock markets tend to often dip on Mondays. The reasons for this may be from a build-up of bad news over the weekend, or just an overall gloomy "back to work" sentiment a lot of people (including investors) feel on Monday mornings. For the prudent investor, grab your coffee early and look for the deals that Monday's can offer. After all, it is considered the best day of the week to buy stocks.
Secondly, Three Day Holidays can have an even more pronounced effect, or the opposite effect, depending how you look at it. Prior to a long weekend there is usually a positive, celebratory feel in the air and this leads to a trend where stock prices often rise on the day(s) leading up to the long weekend.
Be aware of Mondays & Holidays and leverage these tips to help boost your stock portfolio!
4. Summer
There is an adage that goes like this: "Sell the beginning of May, come back after Labour Day". Of course this is a generalization and should be only used as a guideline. There is evidence, however, that suggests that summer is often a bearish time... depending on the stocks you invest in. Ah-ha... that is the key! Not all stocks act the same in bearish and bullish seasons. Although summer is considered 'bearish', the Dow Utility stocks tend to act bullish during this time. At the beginning of April, you might want to start looking at "IDU" (an iShares ETF that mimics the Dow US Utilities Index). IDU is generally bullish from May to September.
By investing in an ETF, such as IDU, you are trading the whole index and not an individual stock, and this is important. When we are looking at deep seasonal undercurrent patterns, the effects of these are more visible in the whole market itself rather than any one individual stock. Summer is more than just a great season; it's a great seasonality opportunity!
5. Winter
IDU tends to turn bearish come October. As we enter the winter season, our focus is better drawn to the Dow Industrials, which are usually bullish from October to April. Again, we want to look at trading the whole index here, and a great way to do this is through the "DIA" SPDR ETF which mimics the Dow Jones Industrial Average.
Keep in mind, as you trade, that seasonality patterns are general trends and are never written in stone. While understanding these patterns can certainly increase your odds of success, remember to always protect your trades by having stop losses in place.
To show you just how powerful seasonality can be, have a look at the graphic here. The black line represents the return you would have achieved if you had invested in small-caps in the winter, from September 30th to April 30th of every year since 1950. In total, it would have yielded a 71,301% gain! Compare that to the red line which shows the return if you had done the opposite, investing in the summer from April 30th to September 30th. You would have only yielded 240%, which isn't much for over 50 years worth of investment. It's clear that the winter months are much more profitable so keeping this phenomenon in mind can help you maximize the potential of your portfolio.
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Kyle Sarwal is an investment expert and founder of TradeProspect.com.
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