With the autumn season in full-swing, it won’t be long until Halloween rolls around. Those who love this spooky holiday are not the only ones who are excited for the end of October. As a matter of fact, there are a good amount of investors who are eager for the 31st. But why is that? Well, it’s all because of an exciting, albeit peculiar, tactic that’s commonly known as the Halloween strategy.
What is it?
The ‘Halloween strategy’ (aka. the ‘Halloween effect’ or ‘Halloween indicator’) is one of many market-timing strategies. Its foundation draws from the theory that stocks will perform better between October 31st (Halloween) and May 1st. Moreover, they will fare better during this period than they would between the beginning of May and the end of October.
The theory hypothesizes that it would be wise to purchase stocks in November, then hold them through the winter months. Afterwards, you can sell them in April, all while you invest in other asset classes from May through October. Those who subscribe to this method recommend that you should not make any investments during the summer months.
The very idea that investors are able to time the market in this specific manner contradicts the buy-and-hold strategy. In that case, an investor will sometimes ride out the down months, thus investing for the longer term. The superior results appear to counter the basic premise of the Efficient Markets Hypothesis. Furthermore, the behaviour of stocks acts in a way that is completely random.
“Sell in May and Go Away”
The Halloween strategy shares close connections with the typical advice of selling in May and then going away. This is a well-known saying in the world of finances. It draws from the historical under-performance of numerous stocks in the six-month “summery” period. One that commences in May and comes to an end in October. The results in comparison to the “wintery” six-month period from November to April are quite telling. Should an investor decide to follow this investment strategy, then they would divest their equity holdings in May (or the late spring). In November (or the middle of autumn), they would invest again.
Some investors will find this strategy to be much more rewarding than remaining in the equity markets during the year. They believe that, as warm weather starts to set in, low volumes and few market participants (probably on vacations) can make things risky. Or, at the very least, it can lead to a lackluster market period.
Understanding the concept
It’s important to point out that, in actuality, some variation of this strategy has been around for a while. The adage has been coined so often in financial media that it would experience repetition throughout the previous two centuries. Moreover, the longer version is some variation of these particular words:
“Sell in May, go away, come again St. Leger’s day (September 15)”
A common belief is that the notion of abandoning stocks in May every year originates in the United Kingdom. Specifically, where those with privilege leave London for their country estates during the summer season. They largely ignore their investment portfolios, only to return later in September. Those subscribing to this notion likely have a common expectation. That being traders, salesmen, brokers, equity analysts, and others figures in the investment community leave their metropolitan financial centres in favour of oases. Such locations include the Hamptons in New York, Nantucket in Massachusetts, or their equivalents elsewhere.
Sven Bouman and Ben Jacobsen would go on to publish an interesting paper in the American Economic Review. It primarily studies the performance of stocks from November to April and would dub this the ‘Halloween Indicator’. According to their observations, an investor may use the Halloween strategy to invest for one six-month period. Moreover, they will be out of the market for the remaining six months of the year. In this case, they would theoretically reap the benefits of an annual return. However, this will only be with half the exposure of someone investing in stocks throughout the year.
What causes it?
Realistically speaking, no one can definitively identify a reason for this seasonal anomaly. It’s true that a lot of market watchers think that investment professionals’ summer vacations have an impact on market liquidity. Alternatively, investors’ hostility towards risk during the summer is partially accountable for the difference in seasonal returns. However, these notions are under the assumption that an increase in participation equates to an increase in gains.
Market crashes and other similar disasters concerning investments are attended by peak levels in both volume and participation. Therefore, the assumption of participation increase probably has at least some correlation with gains. But, on the other hand, it’s not necessarily the main cause of gains.
Electronic trading gives investors across the globe the ability to participate, and they can do so from either the boardroom or the beach. With that in mind, it’s clear that proximity to trading resources is not a viable explanation either.
You will find no shortage of theories to support whatever you want to believe concerning the Halloween strategy. For all the different opinions there are about this interesting effect, there are just as many theories supporting those opinions. The Halloween strategy is compelling primarily because it functions as both an empirical abnormality and a solid mystery.
The October Effect
There is another effect that takes place around the same time as the Halloween strategy. This one is the appropriately titled ‘October effect’. Even though they sound similar, both are distinct; in fact, they are polar opposites.
The ‘October effect’ is commonly seen as a market anomaly. One in which stocks will suddenly start to decline during the month of October. Rather than an actual phenomenon, the October effect is primarily seen as a psychological expectation. This is because most statistics go against the theory. There are some nervous investors during October that worry because of the market crashes that typically occur during this month.
This unfavourable view on October is not at all baseless. The events responsible for October’s reputation for stock losses go back several decades. The most prominent ones include the following:
- The Panic of 1907
- Black Tuesday (1929)
- Black Thursday (1929)
- Two instances of Black Mondays, with one in 1929 and the other in 1987
Out of all these crashes, one stands out as being arguably the worst single-day decline. That is Black Monday of 1987, which was the great crash occurring on October 19. During this event, the Dow would go on to plummet 22.6% in a single day.
Obviously, the other black days were part of the process that would result in the Great Depression. This, as we all know, was a catastrophic disaster in economics. It stood once unrivalled up until the mortgage meltdown almost took out the whole global economy.
Is it worth all the worry?
Advocates of the October effect typically make the argument that this month is when some of the greatest stock market crashes occur. To reiterate an earlier point, there is statistical evidence that does not wholly support the phenomenon of stocks trading lower in October. Be that as it may, the psychological expectations of the October effect are still prevalent.
Generally speaking, the October effect has a tendency to be overrated. Pushing the dark titles aside, this concentration of days is not significant in a statistical sense. As a matter of fact, the month preceding it, September, actually contains more historical down months. October, from a historical perspective, marks the end of more bear markets than it acts as the beginning.
Unsurprisingly, this places October in a peculiar perspective when it comes to contrarian buying. Should investors view a month negatively, then it will in turn create opportunities to buy during that particular month. However, the end of the October effect is already at hand. That is, if it ever was a market force.
