How to Profit from First Day of Month Gains in the Markets

Includes: EDC, FAS, QQQ, SPY
by: Everyday Finance

You may have seen articles popping up here and there highlighting how the gains in the S&P500 (NYSEARCA:SPY), Nasdaq (QQQQ) and other broad market indices tend to be up on day one of the month and then subside in subsequent days. This is believed to be due to 401(k), IRA and other monthly entrants into the market on day one of the month. Regardless of market direction, if you traded in and out on day one only, you'd be up nicely - at double digit annualized rates of return, depending on the time period selected. This has been broadly true, especially in the past few years. I started to question this phenomena early in 2010 and have profited from it handsomely. I'll detail just how I overcome trading costs, taxes and standard deviation within.

First Day Trading Results Back to 2000

Aside from just relying on recent data and news accounts, I wanted to see how well this phenomena held up during various market conditions ranging from bull markets to financial collapses to the current recovery. By comparing the closing price on the final trading day of every month to the closing prices the next single day, two days, three days, and so on, what I found was that the optimal time to hold was actually two full days, not just one day like many news articles are highlighting. I highlighted below what the gain/loss ratio was for each year as well. It was pleasing to see that even in a horrendous market like we saw in 2008 and 2009, you broke even on the day one strategy in 2009 and the only time you would have lost money was the two day strategy in 2009 - the worst market in recent history where investors lost over 50% peak to trough. There was a loss in 2002 and some ties as well, but as you can see, the wins greatly outnumbered the losses. Much better than a 50% roll of the dice, right? Data below was through mid-2010 to look back a full 10 years-plus.

1st Day 1st & 2nd Day
yr 2001 gain 7 8
loss 5 4
yr 2002 gain 7 5
loss 5 7
yr 2003 gain 9 9
loss 3 3
yr 2004 gain 9 10
loss 3 2
yr 2005 gain 8 9
loss 4 3
yr 2006 gain 6 7
loss 6 5
yr 2007 gain 8 9
loss 4 3
yr 2008 gain 6 4
loss 6 8
yr 2009 gain 8 8
loss 4 4
yr 2010 gain 5 5
loss 1 1
Click to enlarge

How to Trade the Day 1 Market Phenomena

Regardless of whether you choose to focus on trading out on the first day of the month or the second, you should enter in late afternoon on the final trading day of the prior month. Next, you'll hear the naysayers touting how this strategy won't work because of either 1) Market Efficiency Hypothesis or 2) Transaction costs. I can counter both.

Market efficiency has not eroded this phenomena since a) rumors have abounded for years on this phenomena, yet it still continues to occur consistently, and b) many retail investors don't participate because they believe transaction costs and taxes will render the exercise useless.

Transaction costs can be overcome through the use of leverage. While this obviously amplifies your risk and you should tread carefully, with just a few thousdand dollars, I've been consistently making several hundred dollars each month since I started with a net profit of over $3,000 by trading only $5,000-$10,000 for a single day once per month - for only six months. Not too shabby!

I've relied on both leveraged ETFs as well as stock options strategies like option spreads and straight out call options. Even if the S&P500 only rallies 0.6% during a given period, that's a 1.8% return with a 3X leveraged ETF. To get even more Beta, I sometimes use a volatile ETF like the Financials 3X (NYSEARCA:FAS) or Emerging Markets 3X (NYSEARCA:EDC), realizing of course, that these are not perfectly correlated to the S&P500. Stock options are dependant upon duration and strike, but I like to stick with weekly options on high volume symbols like SPY to minimize the bid/ask spread and shield myself from unnecessary time value priced in. This month, for instance, I had purchased 12 SPY options strike 129 for expiry this Friday. My returns are well over 100%.

I do want to emphasize a few things:

  • This is a very high risk strategy - using options and/or leveraged ETFs. Don't mortgage your house to do this. I use speculative funds only.
  • There will be down months. My data shows that there are some periods of up to five down months in a row. So don't fall prey to increasing your "bet" after a losing month and continuing to make the same mistake consistently.
  • Be consistent with your strategy. To do otherwise would render the historical data - and predicted outcome - moot. Buy on the final day of the month and sell on either day one or two.
  • I don't advocate leveraged ETFs in general since all leveraged ETFs go to zero given enough time. But this is a single to two day trade, which is what they were designed for in my opinion.
  • Don't blame me or Seeking Alpha if you lose money - you've been warned!

Do You Have Additional Ideas on How to Exploit This Strategy? Is It Worth the Risk?

Disclosure: I am long SPY.