Whether you’re a regular Warren Buffet or a novice trader, you may have heard about the Halloween effect. But, just in case you think we’re talking about the effect of watching spooky movies and drinking pumpkin spice lattes, let us clarify.
In this article, we’ll discuss everything you need to know about this seasonal effect and how much legitimacy it holds in the world of investing.
What’s the Halloween effect?
Also referred to as the Halloween indicator, this theory is based on the thesis that global equity markets generate higher returns between the 31st of October and the 1st of May than during the other six months of the year.
Thus, followers of the Halloween theory buy stocks starting on the first trading day in November and then sell their stocks before the last trading day in April. And, because this theory advocates investors to purchase equities during the October to May timeframe, it encourages investors to focus their trading efforts on other asset classes during the May to October timeframe. These other asset classes might include bonds, money market investments, or fixed income.
Born from the Halloween indicator is the phrase, “sell in May and go away.” So, let’s explore what the saying means.
“Sell in May and go away.”
This well-known investing adage born out of the Halloween effect quite literally tells investors to sell their stocks in May, get away from the markets for a bit, and then re-enter the stock market on October 31st.
Thus, the market adage argues that investors who close their positions in May and reopen them at the end of October will produce a better annual return on their portfolio than if they stayed invested in their stocks throughout the entire year. One reason for this hypothesis is that May indicates the start of a bear market, and so investors are advised to close their positions and hold cash instead.
How did the Halloween effect become known in the world of investing?
As investors began noticing patterns in equity returns during the winter months, many started using the investing adage “sell in May and go away.” This maxim was frequently mentioned in newspapers in the UK and gained popularity among retail investors much later, in the 1980s. The spike in popularity was due to The Wall Street Journal addressing the highly anticipated question, “what is the Halloween indicator?”.
Thus, during the time of big hair and breakdancing, the Wall Street Journal published a piece on the British stock market that brought the old investing adage back into the everyday investor’s vernacular. And so, the Halloween indicator became a well-known theory that ultimately led to the market timing strategy of selling your stocks in May and reopening your positions around Halloween.
Can the Halloween effect be explained?
The practice of abandoning your Halloween stocks at the beginning of May is widely believed to have originated in the United Kingdom sometime between 1694 and 1776.
Typically, affluent families and wealthy investors in 16th-century London would sell their stocks at the onset of summer so they could leave for their country vacation homes to bask in the sun. So, during this time they’d have to set their investment portfolios aside. Then, at the end of summer or early fall, they’d return home and reopen their positions on the stock market.
Many believe that this is how the privileged class in London contributed to the pattern of stocks performing better between October and May than the other half of the year. The increase in capital being invested in the fall brought greater liquidity in the market until these investors left for vacations again in May. Likewise, ignoring their positions during the summer months put the markets into a temporary slump.
Now, wealthy investors leaving their positions during the summertime is only part of the equation. While it’s plausible that it did indeed cause a Halloween effect, no one has been able to find conclusive evidence for the seasonal anomaly. Thus, the Halloween strategy remains a fascinating mystery today.
However, some trading experts stand by the notion that the higher returns between October and May can be explained by changes in trading volume or shifts in interest rates. Moreover, they believe it could simply be the result of a calendar time anomaly.
Calendar time anomalies
A calendar time anomaly is any market occurrence that deviates from what’s expected because of the time of year it occurs. In other words, it’s an economic oddity that seems to be related to the calendar, like the day, the month, or the season.
So, the Halloween indicator is an example of a calendar anomaly because it’s a seasonal tendency that demonstrates a repetitive behavior (or at least somewhat repetitive) in a financial market that appears to be correlated with our calendar.
Does following the Halloween indicator in the stock market really work?
While there certainly is some truth that the Halloween effect has made an impact on the financial markets, many investors wonder if the seasonal indicator holds enough legitimacy to be worth incorporating into their overall investing strategy.
Now, while you don’t want to put all of your faith into the stock market Halloween indicator, it’s important to note there has been a general pattern that shows the seasonal strategy is worthy of consideration.
Let’s peer into the world of crypto
The ever-popular digital coins market showed a crypto Halloween indicator between the years 2015 and 2017. Thus, the crypto scene provides proof that there is some validity to the seasonal anomaly.
In 2015, the bear market came to an end on precisely October 31st. And, from that day forward until the end of May, the crypto market boosted its value by a whopping 41%. On October 31st of 2016, Bitcoin began making waves in the market and continued this streak until May 1st of 2017. During this time, it provided its investors with a return of 117%.
In 2017, Bitcoin skyrocketed and hit an all-time high of $20,000 per share. And, on what date did this all-time high happen? You guessed it– Halloween. From October 31st, 2017 to May 2018, Bitcoin reached $20,000 per share and then went back down to $5,800 per share.
Although the patterns during these three years prove it can be wise to “sell in May and go away,” we must remember that past performances aren’t necessarily an indication of future results. Especially in an extremely volatile market like crypto. So, perhaps this is why the Efficient Market Hypothesis (EMH) offers an opposing viewpoint on the Halloween indicator.
Why the Efficient Market Hypothesis thinks the Halloween effect may be a bunch of hocus pocus
The EMH states that it’s impossible to “beat the market” consistently because stock prices reflect all available information that comes into the market in real time. Thus, the hypothesis postulates that securities are always accurately priced– making the market efficient. This would mean that there’s no way to leverage mispricings using stock market timing services or calendar anomalies, like the Halloween indicator, because mispricings simply do not exist.
However, as history has shown us in the crypto world, one could use the Halloween anomaly to counter this hypothesis and prove that it does bear some validity.
So, whether you stand by the Halloween effect or think it’s a bunch of hocus pocus, you can’t argue with the facts that have been shared over the past several decades. Let’s take a look at some facts that were presented in Sven Bouman and Ben Jacobsen’s seminal piece of research, “The Halloween indicator, ‘sell in May and Go Away’: Another Puzzle.”
The groundbreaking paper that left investors quizzically intrigued
Bouman and Jacobsen’s paper took a close look at the performance of stocks in 37 markets from May to October and from November to April over a couple of decades.
In 36 of the 37 developed markets they studied between the years of 1973 and 1998, the authors identified returns from November to April to be higher than returns between May and October by a statistically significant amount. Thus, they concluded that an investor who utilized the Halloween strategy would reap the best part of an annual return with only half the exposure of someone who stays invested in stocks the entire year.
What left Bouman and Jacobsen utterly puzzled was that despite the seasonal anomaly’s economic rewards being widely known, it hadn’t been arbitraged away. So, today the seasonal effect remains a compelling theory that excites some investors and leaves others skeptical.
The Halloween effect + technical analysis
While you don’t want to rely on the Halloween indicator as your only investing tactic, combining the seasonal strategy with technical analysis can help set you up for success in the market.
With Chart Prime’s technical analysis software, we give you an edge in any market, no matter what your skill level is. Check out our user-friendly tutorials to get a clear sense of how you can become a more efficient trader with the help of our intelligent tools.