What Is the Halloween Strategy?
The Halloween strategy, also commonly known as the Halloween effect, or Halloween indicator, is a market-timing strategy which is established using a hypothesis that the performance of stocks between 31 October (Halloween) and 1 May is better in comparison with the time period between the beginning of May and the end of October.
According to this strategy, it is advisable to invest in other assets from May to November and buy stocks in November and sell them in April after holding them through the winter months. Several investors following this strategy suggest that there should be no investments made in stocks during the summer months.
In contrast with the buy-and-hold strategy, in which the stocks can be sold in down months and long-term investments can be made, the investors can time the market using the Halloween strategy. The results of this strategy are also inconsistent with the proposition of the Efficient Markets Hypothesis and that of the stocks behaving in an entirely random way.
Understanding the strategy
The Halloween strategy is very much similar to the often-heard advice of sell in May and go away. A notable point is that this strategy has been witnessing changes for over two centuries and the latest version of the strategy was: Sell in May, go away, come again St. Leger’s Day (15 September). A lot of people believed that the Halloween strategy had its origins in the UK as the privileged class would generally abandon their stocks every year in May as it headed away from London towards their country estates for the summer. As these people would return in September, their investment portfolios were usually ignored until then. Those who endorsed this concept would potentially anticipate that it would be customary for the investment community, which includes brokers, traders, equity analysts, and others, to go away from their metropolitan financial centers during summer months.
However, a paper was published by the American Economic Review by Sven Bouman and Ben Jacobsen in December 2002 that particularly tracked the stock performance from November to April to understand the functioning of the Halloween indicator. As per the report, theoretically an investor was likely to earn high annual return by entirely investing for the six-month period and not participate in the market for the rest six months, as compared to those who invested all-round the year.
How does the strategy perform?
There is an ample amount of evidence available regarding the worthiness of the Halloween strategy. According to historical records of stock returns, Halloween strategy’s premise has been proved right for most part of the last half century. The investors, during the months of November to April, have actually been able to achieve higher capital gains as compared to the rest of the months.
If the strategy is used over a period of five years, there’s a chance of over 80% to get higher returns than the average market returns by selling the stocks in May. In case of a ten-year time period, the percentage of successfully beating the market goes up to over 90%.
Cause and effect
The seasonal anomaly of the Halloween strategy is still not understood well and the reason behind its functioning remains inconclusive. Several market analysts believe that the liquidity of the market isn’t influenced by the so-called summer vacation of the investment professionals, and it may be somewhat influenced by the risk aversion of investors during the summer months which may lead to variation in seasonal returns, the underline assumptions of these propositions is that increased gains are a result of increased participation.
However, this assumption may not be entirely true and there may be a correlation between the two but that doesn’t necessarily mean that increased participation will lead to increased gains, which can be seen during market crashes and related disasters in the investment arena when the volume and participation level is the highest of all times.
How close an investor is to the trading resources isn’t a plausible explanation for the Halloween strategy either in the times of electronic trading, through which investors from all over the world can participate in the stock markets.