Digging Under an Old Wall Street Adage

 | Sep 23, 2013 | 9:20 AM EDT  | Comments
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This commentary originally appeared Sept. 22 on Real Money Pro – Click here to learn about this dynamic market information service for active traders.

"Get your facts first, and then you can distort them as much as you please." -- Mark Twain

For those unfamiliar with the "Sell in May and Go Away" strategy, it simply suggests that traders sell their equity holdings on May 1, and then repurchase them on Nov. 1. The idea is that investors would be better off, over time, avoiding the entire six-month period between May 1 and Oct. 31. Just so there is no confusion, I want to be perfectly clear that this is an index-based study. It is not based on the returns of any one stock but, rather, the performance of the Dow Jones Industrial Average.

Using a data set that spans from May 1, 1985, to Sept. 19, 2013, let's examine how the Dow performed during the two six-month periods this strategy addresses. First, we'll look at how the Dow has performed between May 1 and Oct. 31. Then we'll shift gears and look at how the index performed between Nov. 1 and April 30.

First the good: Better than 9% gains were registered between May 1 and Oct. 31 in 1985, 1989, 1995, 2003 and 2009. Let's not turn our noses up at the current year's gains, either. Since May 1 of 2013, the Dow has risen roughly 5.4%.

Unfortunately, it's not all sunshine and rainbows. Out of the 29 six-month periods in question, 11 finished in the red -- and, of those four saw losses in excess of 10%. Now, every trader knows losses happen. So, rather than home in on the stellar gains or outsized loses, let's consider how the Dow has performed, on average, since 1985, between May 1 and Oct. 31.

The average Dow return for that period, it turns out, is a dismal 1.15%. Everyone needs to manage their own risk but, in my view, earning roughly 1% over the course of six months seem a bit thin. As a reminder, that 1.15% figure does not take into account trading commissions, execution slippage or dividends.

But we know that simple percentages don't drive the point home for some traders, so let's put a dollar figure to it. If you had invested $100,000 into the Dow, on May 1 of every year since 1985, and then liquidate your entire position six months later, on Oct. 31, your average gain would have been $1,150. Your accumulated gains over the 29 years that this study is focused on, and not taking any potential compounding into consideration, would amount to roughly $33,355. We'd all like to have an additional 33K in our back pocket, but with six-month returns like these, I suspect some might opt for a simple certificate of deposit or short-term Treasury bill.

Buy in November, and Go Away Until May?

"If the facts don't fit the theory, change the facts." -- Albert Einstein

We all know that statistics can be found, and on occasion, massaged, to back up nearly any argument. Nonetheless, the simple price data used to justify not being invested in the Dow between May 1 and Oct. 31 seems more than a little compelling. But what about the six months from Nov. 1 to April 30?  

What if one were to buy the Dow at the open of trading on Nov. 1, and liquidate that entire position at the close of trading on the last day of April?

Looking back over the 29 six-month periods in question (again, since 1985), the Dow has racked up gains in excess of 9% an impressive 15 times. Among those occurrences, the index recorded gains in excess of 20% in 1985-1986, 1986-1987, 1997-1998 and 1998-1999. As for losing periods, the Dow finished in the red on three separate occasions, with the worst occurring during the 2008-2009 bear market. The Dow lost 12.42% between Nov. 1, 2008 and April 30, 2009.

Let's get down to the bottom line. If one had executed this same strategy -- buying the open on Nov. 1 and selling the close on the last day of April the following year -- their average gain, since 1985, would be a very respectable 9.09%.

Put another way, if $100,000 were invested in the Dow on Nov. 1 of every year since 1985, and liquidated six months later, on the last day of April the following year, the gains would have accumulated to roughly $254,000. Again, this assumes all gains or losses were absorbed on a yearly basis, and that the trade began anew, every year, with the same 100,000. Obviously, if one were to put the benefits of compounding to work, the results would be quite impressive.  

Here's the bottom line. When one ignores the sarcasm and emotional bull-and-bear rhetoric, there is no question that -- over time -- the returns earned from investing in the Dow between Nov. 1 and April 30 are far superior to those earned between May 1 and Oct. 31.  

Now that we have the statistics, what do we do with them?

"Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence." -- John Adams

I can't conclude a discussion on Sell in May and Go Away without adding a few of my own, non-statistic-based thoughts on the strategy. To begin, I didn't liquidate a single one of my own long-term investment positions based on this strategy. This exercise began as a study on the Dow Jones Industrial Average, and while similar results are found when applied to the Nasdaq and S&P 500, the data isn't going to convince me to sell my investment positions in stocks like Medtronic (MDT), General Dynamics (GD) or ConocoPhillips (COP).

So what's the point of this, or any index based seasonality study? It's simple, really. While I enjoy doing work into specific companies for longer-term investments, I am a trader at heart -- and statistical evidence such as this simply should not be ignored. In my view, traders can take the traditional Sell in May and Go Away strategy, and studies like it, and begin the process of designing a strategy that fits their own unique risk profile. Would I allocate 75% or even 50% of my book to such an idea? No, probably not. But with figures such as the ones presented in this study, there isn't a snowball's chance in Texas that I'd turn a blind eye and ignore the trading potential here.

It's highly unlikely, and generally illogical, to assume that a fundamentally based investor or aggressive momentum trader is going to liquidate their individual stock holding on May 1 every year. That said, it's equally illogical for such investors to refer to the old adage of Sell in May and Go Away, and apply the data in a manner that was never intended. Every strategy, be it mechanical or discretionary, ebbs and flows. Nothing works 100% of the time. With this in mind, you should not look at the Dow's current May-to-October gains, and use this to haphazardly mock that Wall Street adage.

I'd be remiss if I failed recommend an additional source of data for those interested in an even deeper understanding of the Sell in May and Go Away strategy. Though the data used for this study was pulled off a simple monthly bar chart, the best source of information for this strategy, and others like it, can be found in Jeffrey A. Hirsch's book Stock Trader's Almanac 2013.

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