One of the few technical signals that actually works in stocks, try this seasonal strategy to sell in May and make more money!
I don’t usually cover technical stock investing or signals on the blog. I am a buy-and-hold investor and I think investing for long-term goals is what works best for the vast majority of investors.
When you start trying to ‘beat the market’ with technical signals and trading, that’s when you complicate investing and too often end up losing money.
But that doesn’t mean there aren’t technical signals out there that do work. For those with a higher risk tolerance for stocks, some seasonal investing strategies have outperformed the buy-and-hold strategy over time.
One of my favorite is the adage, Sell in May and Go Away.
Let’s look at the stock-selling signal, some fundamental reasons why it works and how you can use it with your portfolio.
What is Technical Trading?
Technical analysis in stock investing is about looking for patterns in stock prices and returns. The investing strategy uses statistical analysis to uncover patterns in the past that may persist into the future.
Stock traders can then buy or sell stocks before the technical signal happens to make a quick profit.
A couple of warnings on technical trading strategies:
- Most research on stock investing shows that the majority of technical strategies do not work or at least don’t produce positive returns after fees. The reason is obvious, if the strategy worked without fail, investors would pile into the trade and nobody would make money.
- Technical trading strategies will increase your taxes and fees. Most technical stock signals mean buying and selling often and within a year. That means lots of trading fees and short-term capital gains which are taxed as income instead of the lower rate on long-term capital gains.
- Technical trading strategies can get extremely complicated, involving deep statistical analysis. Missing the exact signal can mean the difference between making money and losing it.
Whereas technical stock trading can get extremely complicated, I usually prefer fundamental analysis for investing. Fundamental analysis is looking at the financial statements and factors behind a company’s success or outlook.
Review these six rules for picking stocks on fundamental analysis.
What is Seasonality in Stocks?
One popular technical trading strategy is the idea of seasonality in stocks, the idea that stock prices tend to increase/decrease in specific months. Seasonality is one of my favorite market anomalies, times when the market seems to repeat itself.
Market seasonality is a reflection of cultural behavior. Back when farming was the big driver of the U.S. economy, August was the best market month. Now that farming makes up less than 2% of the U.S. economy it’s one of the worst, as it falls during a time when traders and investors prefer the golf course, beach, or pool to the trading floor or computer screen.
Institutional investors’ efforts in the fourth quarter to beef up their numbers can help drive the market higher, as does holiday shopping and an influx of year-end bonus money.
This is followed by the New Year, which can tend to bring a positive “new-leaf” mentality to forecasts and predictions and the anticipation of strong fourth- and first-quarter earnings and drives the market higher into the second quarter.
What Does Sell in May Mean for Stocks?
One of the most popular and persistent seasonal investing strategies is the idea that investors should sell in May of each year and sit out the market until November.
The phrase comes from an old British adage, “Sell in May and go away, come back on St. Leger Day.” Established in 1776, the St. Leger Stakes is the last flat thoroughbred horserace of the year and the final leg of the English Triple Crown. Apparently, once the British horseracing season concludes everyone can get back to the business of buying stocks.
While the St. Leger Stakes has little to do with stock market seasonality, it does coincide with what has historically been the end of the worst months of the year for stocks.
Whether from summer vacations, summer doldrums or just plain self-fulfilling prophecy – trading volume in stocks slumps throughout the summer. It tends to pick back up in late-September as the kids go back to school and mutual funds shift investments to make their third-quarter returns look better.
Although there may be some shifts in seasonality, the record still shows the clear existence of seasonal trends in the stock market.
Investing in the Dow Jones Industrial Average between November 1st and April 30th each year and then switching into fixed income for the other six months has produced reliable returns with reduced risk since 1950.
There are a few years that outside factors have caused a hiccup in market seasonality. Panic caused by financial crisis in 2007-08 caused every asset class aside from U.S. Treasuries to decline substantially, but the bulk of the major decline in equities that occurred during the worst months of 2008 was sidestepped using this strategy.
The chart shows that November, December, January, March, and April have been the top months since 1950. If you add in February, you have an impressive six consecutive month trading strategy.
These six consecutive months gained 14,654.27 Dow points in 62 years, up 48 and down 14. May through October months lost 1,654.97 points, up 37 times and down 25.
David Aronson, author of Evidence-Based Technical Analysis (Wiley 2006), and his colleague Dr. Timothy Masters back-tested the Sell-in-May Stock Strategy using their scientific method from 1987 to April 2006.
They found that from 1987 through April 2006 the S&P 500 generated an annualized return of 16.3% during the Best Six Months compared to 3.9% for the Worst Six Months. Though no back-test can predict future results, in Aronson and Masters' opinion the technical trading signal was sound, valuable, and had predictive power.
Proof for the Sell in May Strategy for Stocks
While just selling your stocks in May and then buying back into the market in November has proven to beat market returns, there is one more technical signal you can add to the strategy for even better returns.
Using the simple Moving Average Convergence Divergence (MACD) indicator developed by Gerald Appel to better time entries and exits into and out of the sell-in-May period nearly triples its cumulative results since 1950.
In up-trending markets, MACD signals get you in earlier and keep you in longer. If the market is trending down, however, entries are delayed until the market turns up and exit points can come a month earlier. Beginning October 1, you might look to catch the market’s first hint of an uptrend after the summer doldrums; beginning April 1, considering preparing to exit seasonal positions as soon as the market falters.
The results are astounding. Instead of $10,000 gaining $674,073 over the 63 recent years when invested only during the best six months, the gain nearly tripled to $1,878,557. The $1,024 loss during the worst six months expanded to a loss of $6,723. Impressive results for being invested during only 6.3 months of the year on average.
Putting the Sell in May Technical Strategy to Work
A more conservative way to execute this technical investing strategy, which I call the in-or-out approach, entails switching capital between stocks and bonds.
During the best six months for investing, an investor or trader is fully invested in stocks. One inexpensive way to gain stock market exposure is through index-tracking ETFs and mutual funds.
During the worst six months for stocks, you could then switch into Treasury bonds, money market funds, or a short stock fund. Money market funds may be most conservative, but are likely to offer the smallest return.
Consider Lending Club and peer loan investing for part of your bond investing. P2P loans offer the protection of fixed-income investments but higher returns than corporate bonds or Treasuries. I have over $20,000 invested in peer loans and have averaged nearly 10% annual returns for several years.
Short stock funds offer potentially greater returns, but more risk. If the market moves sideways or higher during the worst six months, a short fund is likely to lose money. Treasuries can offer a combination of decent returns with limited risk.
Another option for investors that don’t want to sell their stocks and risk higher taxes on short-term capital gains is just to hedge your portfolio with put options.
This would mean buying put options against your stocks or against the S&P 500 which gives you protection from falling stock prices. I detailed how to use options investing to reduce risk in an earlier post along with several great strategies.
The sell-in-May investing strategy may work better in tax-advantaged retirement accounts where you don’t have to worry about short-term capital gains eating into your returns.
Another benefit of stock market seasonality, you will probably find summertime vacations and activities much more enjoyable because you will not be concerned with stock market gyrations while your nest egg is parked in cash or bonds. Since 1950, there have only been 9 years when the DJIA sell-in-May strategy failed to delivery market gains.
Technical investing strategies aren’t for everyone but there are some technical signals that seem to work year-after-year. The best technical signals seem to revolve around stock market seasonality and the tendency for best and worst months for returns. The sell-in-May strategy has proven to be reliable for decades and may just help you beat the stock market.