Testing the Turn-of-the-Month Strategy

My recent posts about stock market strength around options expiration week left out two important parts of the month – the beginning and the end. In this report, I’ll share a strategy for trading the turn-of-the-month. This observation will be added to the State of the Market report.

I’m following in the footprints of giants. The turn-of-the-month has been discussed on many occasions by others - notably by CXO Advisory here, here and here.

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[logarithmically-scaled]

In a nutshell, the market has generally been bullish around the beginning and end of each trading month. By my count, this turn-of-the-month bullishness usually covers the first three and final four trading days.

The graph above shows the results of a trading strategy long the S&P 500 on these turn-of-the-month days (green) versus both buy and hold (blue) and a strategy only long non-turn-of-the-month days (red) from 1970 to 11/2008.

Note that this is a proof of concept so this test is frictionless (no transaction costs or slippage) and does not account for return on cash. For the record however, these results could be duplicated using actively traded mutual funds such as those from Rydex or ProFunds.

And for the number lovers:

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Clearly, these seven turn-of-the-month days, despite including only a third of all days, are far more bullish than the average day. Such a turn-of-the-month strategy would have outperformed the market in terms of absolute and risk-adjusted returns and significantly reduced downside volatility.

More turn-of-the-month statistics

The following chart shows average daily returns for the S&P 500 on the first seven (left half of graph) and last seven (right half) days of the month from 1970. Geek note: these results have been de-trended by subtracting the average daily return of all whole months.

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The bold red line represents an average of all observations and the lighter red lines individual decades in the sample. On average, immediately after the first three days of the month and immediately prior to the last four, the market has dipped (leading into the bearish weeks prior and after options expiration).

Last thoughts

As I wrote previously, I’m not a big fan of seasonality plays, but both of these have been strong enough and consistent enough that I will be adding them to the State of the Market report. I wouldn’t trade either alone, but I would consider them as one of many, many things I’m looking at.

In a follow up post, I’ll combine this turn-of-the-market strategy with the options expiration week strategy, effectively canvassing the entire month.

Comments

[John Lounsbury:]

This is a tendency that has been mentioned often over the years. It is good to see some analysis on the subject.

2008 Dec 22 12:05 PM