How Is Halloween's Strategy Formulated?
The Halloween strategy, Halloween effect, or Halloween indicator is a market-timing technique based on the premise that equities perform better between October 31 (Halloween) and May 1 than they do from May 1 to the end of October. According to the plan, it is prudent to purchase equities in November, hold them through the winter, and then sell in April, while investing in other asset classes from May to October. Some adherents of this strategy advise against investing at all during the summer months.
The notion that investors can time the market in this manner is in direct opposition to the buy-and-hold strategy, which allows an investor to ride out bad months and invest for the long term. The superior results appear to violate the Efficient Markets Hypothesis's premise that equities behave randomly.
- According to the Halloween approach, investors should be fully engaged in inequities from November to April and completely out of stocks from May to October.
- Variations on this method and its assumptions have existed for well over a century.
- While there is evidence that this method works overtime, no one has provided a sufficient explanation for why it works.
- The Halloween indicator is intriguing since it is both an empirical anomaly and a mystery.
Recognize Halloween's Strategy
Halloween is inextricably linked to the oft-repeated exhortation to sell in May and leave. It's worth mentioning that some form of this method has existed for an extended period of time. The aphorism so frequently coined in financial media was also repeated during the last two centuries, with a longer version consisting of some variation of the following words: Sell in May, leave in June, return on St. Leger's day.
Many believe that the tradition of selling equities in May originated in the United Kingdom, where the privileged class would leave London for the summer and retreat to their country estates, mainly disregarding their investment portfolios until September. According to those who subscribe to this view, it is usual for salespeople, traders, brokers, equities analysts, and other members of the investment community to escape to summer oases such as the Hamptons in New York, Nantucket in Massachusetts, and their equivalents elsewhere.
However, Sven Bouman and Ben Jacobsen released an article in the American Economic Review in which they examined the performance of equities from November to April, coining the term "Halloween Indicator." According to their analysis, an investor who uses the Halloween strategy to invest fully for six months and then exits the market for the remaining six months of the year would theoretically earn the best part of an annual return, but with less than half the exposure of someone who invests year-round in stocks.
The Strategy's Performance
The Halloween plan does have some data to support it. Historical stock returns imply that the Halloween strategy's premise has been mainly correct over the previous half-century—that the months between November and April have really produced greater capital gains for investors than the other months of the year.
Additionally, the results indicate that when utilized over a five-year horizon, a strategy of selling in May is successful in defeating the market more than 80% of the time, and more than 90% of the time when used over a ten-year horizon.
The graph below illustrates the Halloween effect on US stocks from 1970 to 2017 and 1991 to 2017. It illustrates that the Standard & Poor's 500 Index returns significantly more from November to April than it does from May to October.
What Is the Origin of the Halloween Effect?
Nobody has been able to definitively pinpoint the cause of this seasonal phenomenon. While many market observers believe that investment professionals' summer vacations have an effect on market liquidity — or that investors' aversion to risk during the summer months accounts for at least some of the seasonal return difference — these notions presuppose that increased participation results in increased gains.
However, market crashes and similar investment disasters are accompanied by the highest levels of volume and involvement, suggesting that more participation may correlate with gains but is unlikely to be the cause of the gains.
Electronic trading enables investors to participate from anywhere in the globe — as readily from the beach as from the boardroom — thus location to trading resources is unlikely to be a factor. There is no shortage of theories to support whichever version of the Halloween strategy one wishes to believe. As many varied perspectives on the Halloween effect as there are, there are an equal amount of theories to back them up. Halloween is fascinating because it is both an empirical oddity and a mystery.
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