More than any other financial arena, the stock market is psychologically driven. The entire world participates and all sectors within it are affected. There are the high-powered program traders who move giant blocks of orders around in nanoseconds to the peasant farmer in China wondering what he’s going to get for his wares. Wall Street and all the other rapidly emerging world centers reflect and influence the totality
of our lives.
It therefore stands to reason that repeatable calendar-based patterns unique to stocks and the futures indexes that track them exist. Some of them follow credible, readily acceptable fundamentals. There is, for example, a tendency for stock futures to rise in and around the end of a month. This is particularly true during quarterly rollovers. The driver, or market catalyst behind that tendency, is a phenomenon known as “window dressing.”
Fund managers have an incentive to list high-flying stocks in their portfolios. They can advertise a company’s holdings with no further elaboration about when the stocks were acquired, how the clients did during the holding period, etc. It doesn’t matter that the stock was not owned during a time where the participants would have made money. All the company official must do is state that the hot stock, XYZ, was included in the portfolio.
Any professional not foresighted enough to have already purchased XYZ need only bid for it around the month’s end along with all the other charlatans playing the same game. This is why you tend to get price surges in the stock indexes during those rollover times.
EXPLOITING EXPLOITATION
If there is a skewed overperforming time frame, it stands to reason there would be a corresponding cooling off period. To that end, we can examine whether there are set dates where you’d accordingly want to be long or short.
Logic might suggest that we would invariably get the best results making the long time frame longer than the short, but that outcome was vetoed. You should never skew a system to the buy side just to exploit a near relentlessly up-sloping historic testing field. Accordingly, the ground rules stipulate that both time frames must be equal, thereby reducing the risk of wacky results coming from dates being too narrow and targeted.
The setup is simple: find a start date to be long for the next 15-calendar days and then be short for the remaining 15. The system is always in the market, perpetually flipping sides. It was a given that you’d invariably want to be long in and around the month’s end; the optimization process merely revealed how far back from it you’d ideally want to initiate. Here are the resulting rules:
• If today’s date is the 21st, or as close thereafter as you can get considering weekends and holidays, then buy tomorrow on the opening.
• Hold the long through the month’s end, up through and including the following 6th of the month.
• If today is the 6th day of the month, or again as close thereafter as possible, then reverse and sell short on the next open. Hold the short through the following 21st day of the month.
Consider the obvious weak link for a moment: the short side. Believe it or not, the sell side of the system is not something that loses less money overall, it is an actual income generator in its own right.
Keep in mind the near relentless up-sloping nature of the stock market, millennial bubble-burst notwithstanding. In our system, we’re not talking about jumping in and out in narrow-cast, short time frames but rather, of holding a net short position for roughly half the contract’s entire history. Roughly a quarter century, during which time the market’s value increased ten-fold.
“On the short side” shows the results of short positions initiated after the 6th day of the month and exited after the 21st day of the month. This perhaps best demonstrates the value of the system as it derived profit shorting the S&P 500 over its lifespan. “All in” shows the entire system performance on the S&Ps from 1982 to present. A yearly breakdown of results can be found on the Futures “downloads” page at www.futuresmag.com. All trades are docked $100 for slippage/commission.
The day-of-month indicator works across numerous equity indexes
(see “Versatile tool”). All contracts produce both long and short side winners.
TROUBLE IN PARADISE
Admittedly, to trade the system as is would be tough given the size of the drawdowns. It is necessary to hang onto all positions, even horrendously deteriorating ones, without the benefit of stops. Perhaps one way to mitigate this would be to do a second study breaking the trading environment into another two equal parts. Are there other seasonal fundamentals — psychologically based or otherwise — that could give us something we might be able to overlap on the day-of-month idea?
Certainly you can find a lot of conventional wisdom concerning which months of the year to be in and out, or long and short, the market: Black Octobers, Santa Claus rallies, “sell in May and go away,” “as January goes, so goes the year.” Are these all baseless beliefs? They can’t all be bad or we’d have a sure system: “fade all axioms.”
Again, optimization provides the ideal time frames to be long and short for equal durations. We’re again perpetually in the market, flipping long and short every six months, and again we’re profiting on the short and the long side over and above trading costs. Here are the rules:
• Be long from Nov. 2, or as close to it thereafter as possible. Hold the trade through May 1.
• Be short from May 2 through Nov. 1.
The results shown in “Broader bias” (below) speak for themselves. Once again, each market is profitable on both the long and short sides.
We have two independent ideas that share robust qualities. In neither did we cherry pick time frames to be long or short. We’re perpetually in the markets roughly an equal amount of time on each side.
It’s significant that each targeted period (month or year) is only divided into two parts. Intuition would tells
us that we could probably get better results looking for optimal irregular holding periods: be long three days, short two, long four, short seven,
for example. Again though, we’re seeking probable continued good
performance into the future rather than mere impressive looking (overly optimized) statistics.
GETTING TOGETHER
Both ideas conform to market drivers that we intuitively accept. Certainly, most index traders have had direct exposure to the typical up moves from the holiday season through the year-end rollover. Many of us have suffered through summer doldrums and September-October market shocks.
Our second system is in synch with all that. The first system takes
advantage of the window-dressing game. In short, we have two basic building blocks we should be able to trust. Our obvious next step is to overlap the two. Here are the rules:
• If it’s the between Nov. 1 and April 30 (inclusive) and between
the 21st of the month and the following 5th day of the month, then buy the next day at the market.
• If it’s between May 1 and Oct. 31, and the date also falls between the 6th and the 20th, then sell short the next day at market.
• For both long and short trades, exit on the next opening if either condition changes.
With this hybrid system, we’re now long the market roughly a fourth of the time around month-ends from November through the following April, short another quarter (the remaining dates within the remaining months) and on the sidelines the remaining half.
“Better together provides both a visual depiction of how the trade typically look and shows the performance summaries.
The key statistic is the return on account (ROA) figure, which is the net profit divided by the worst drawdown multiplied by 100 to convert it to a percentage figure. The percentage refers to how much your account would have increased had your original startup capital been equal to your worst drawdown.
So, in the case of the Russell, it is presumed that you had a startup of $42,200. Your ultimate $296,050 return is roughly seven times that amount, or the 701.5 ROA figure. This is a way of seeing performance in relative terms — how much pain you would have had to endure at the worst level before achieving the
ultimate result.
The combined side of the Russell is better than the original two systems. It’s also slightly better in the S&P and marginally worse than the better sides in both the Nasdaq and Dow. Overall, the combination exceeds the sum of its parts.
More important, you also get a smoother ride for your equity growth, particularly in the way the combo mitigates losing years. In the S&P 500, for example, there are a few years totaling -$20,000 or more on the initial systems. With the combo, there is only one year as bad as -$14,000.
These are the kinds of results that traders should investigate on their own. The code for all three systems is provided on the Futures “downloads” page at www.futuresmag.com
Upon further exploration, you’ll confirm consistent winning performance in all four indexes, both in the long and short sides. The drawdowns, though better, might still be a bit excessive for the average trader to handle, but additional stop-loss refinement is generally not hard to achieve. And the results shown here should allow traders to optimize their own systems.
Regardless of what index system you use, you can be aware of whether you’re in synch with powerful calendar-based biases or whether you’re fighting them. You can’t lightly dismiss that kind of information.
Note: See below for a link to the yearly breakdown of the Day-of-Month system and for the codes of the systems described in this article.
Art Collins is the author of Market Beaters and When Supertraders Meet Kryptonite. He is currently working on the book, Beating the Financial Futures Market. This article is derived, in part, from portions of that book. E-mail him at artcollins@ameritech.net.
