Stock markets are known to have a tendency for a seasonal behaviour, which has been observed over the years. More specifically, investors believe that stocks have greater probability to rise or fall in specific months of the year than at any other randomly chosen month. The factor of seasonality in the stock markets has been the subject of long debate, as to whether it exists or not, and how strong it really is. Many investors tend to ignore it as being a weak indicator, but their judgement is wrong since no indicator is actually perfectly strong in the financial markets, they all can be wrong. But the seasonality factor does prove that some months are better for stocks, and some months are worse. Therefore investors can actually improve their entry and exit price levels simply by paying attention to this seasonality factor.
History confirms that indeed there is a seasonality factor in the stock market which starts late in the first quarter and ends at the end of the trading year. Stock markets tend to make bottoms in the month of March and October, sometimes there can be more lower lows in November as well. These months of March and October are the number one suspect months where a big low can be made in the stock market. Highs on the other hand are harder to predict based on the seasonality factor, but these nevertheless are believed to occur soon after the lows, as well as in late summer months such as August, and towards the end of the year, such as end of November, as long as November has not been bad from the start, and definitely December tends to be a positive month too. The stock market has a strong tendency to rally in the month of December, and typically it rallies well all the way until the Christmas holidays.
Another important pattern that seasonality brings, is a usually small weakness which becomes apparent in the months of June and July. These are months of huge participation in the stock market, and so is most of August. But only June and July are considered to be weak summer months, August is seen as strong month for stocks. From late August to September investor participation is reduced as many investors and fund managers go on their summer holidays. Moves in the stock market made during the month of late August to September may be of questionable stability as participation and hence trading volume is reduced, and low, below average trading volume means that markets may reverse direction when full participation takes over again.
Stock markets are complicated to trade, but when one makes use of the seasonality factor, in an open minded way, they can expect that deep low in March or October and watch out for any technical signals, that will confirm such a down move. Equally, they will be alert during the strong months, or right after the March or October lows, looking out for any reversal signals that will confirm a rally.
The above chart shows how the month of October has really produced deep lows on the SP500 index, over the years. The period around the month of April tends to be positive for stocks, and the summer months seem more confusing, as if not perfectly following the expected seasonal cycle. But even knowing and expecting some kind of weakness during June and July, followed by strength in August, can prepare traders for which signals to look out first.
Without a doubt, seasonality does exist in the markets, to what extend, is still a subject of debate, but if it has been around for so many years, it is safe to assume that it will continue this way. Stock market seasonality can be used by all kinds of traders and investors, in many markets not just stocks, but it is more profound in the stock market. The fact that stocks tend to decline most in the months of March and October, that alone is very useful information, and it would have saved some investors a lot of money had they watched out for these months. But instead investors tend to focus on single stocks, balance sheet and Price to Earnings Ratios, thinking that that is all there is to successful investing. The fact is each single stock is affected by the actions of the entire market through the trading action of mutual funds, sector focused institutional investors and the large money managers in general, who impact these markets through the huge amounts of funds they manage. The seasonality factor is something that these money managers follow, whether they do it willingly or through collective random action, or because of any other reason, it really does not matter. What matters is to be prepared during the seasonally critical months and be on the lookout for other indicators and signals that will seriously confirm any suspicions regarding seasonal trends. The month of October in particular is the single, most memorable month on the trading calendar, this is where markets always declined by the most amount. Even the black Monday crash of 1987 occurred on 19 October. So one can make the case that they can invest every year in the stock market based on the October seasonal effect alone, by selling before this month, and by buying at some deep October low.
