From the September 01, 2012 issue of Futures Magazine • Subscribe!

Trade less, earn more with Turn of Year timing model

‘Sell in May’ system

The S&P has returned an average of 8.5% minus dividends since 1950. The “Sell in May” crowd point out that 90% of those returns have come in the six months between November and April, and what little equity return you miss out on during your equity hiatus from May through October can be more than offset via the returns of six month interest-bearing securities. 

A study of the optimal periods to be in and out of the market since 1950, assuming only two trades (in and out), revealed that the only modestly negative period for equities is, on average, from Aug. 7 to Oct. 23. So if you assume your cash goes under the couch and your objective is to maximize gains with no aversion to the risk and the volatility of doing so, you would have been served best to be invested in equities the 9½ months from Oct. 23 to Aug. 7 and in cash the remaining 2½ months.  

However, if you assume you could get anywhere from a 3% to 10% alternative return on your non-equity investment, the best alternative followed the Sell in May crowd and suggested equities from Oct. 28 through April 20 (see “Two trades,” right). 

Intermediate seasonal model 

Now the goal is to combine both of these seasonal strategies into one seasonal model. My approach was to give each day from 1950 through June 12, 2012 a rating based on both the Turn of Year barometer and the Sell in May strategy using the following criteria: 

  • If a day’s preceding Nov. 19 – Jan. 19 period returned more than 3%, then that day is assigned a +1.
  • If a day’s preceding Nov. 19 – Jan. 19 period returned 0.0%-3.0%, then that day is assigned a 0.
  • If a day’s preceding Nov. 19 – Jan. 19 period returned less than 0.0%, then that day is assigned a -1.

In addition:

  • If a day falls between April 20 and Oct. 28, then that day is assigned a 0.
  • If a day falls between Oct. 28 and April 20, then that day is assigned a +1.

The ratings for each day then are added to give an overall score between -1 and +2. For example, if the active Turn of Year time frame is negative and you are trading between April 20 and Oct. 28, that day is assigned a -1. If the Turn of Year time frame is greater than 3% and you are trading between Oct. 28 and April 20, each day will receive the maximum +2.  Below are the net results for the market’s performance based on each of the four possible ratings:

Wayne’s intermediate seasonal model

Rating

# of years

Avg annual return

-1

6.85

-19.54

0

15.58

+06.74

+1

25.07

+08.23

+2

15.50

+27.66 

So from 1950 through June 18, 2012, if you had been 100% long during the 15.50 years where both the Turn of Year and Sell in May signals were positive, and then 100% short in the 6.85 years when the net rating was -1, you would have experienced an average annual return of 25.13% during those 22.35 years you were playing the market, which is almost exactly the same net result as the Buy and Hold return over those same 62 years, obtained with one-third of the market exposure. “The power of compounding” (below) shows the results of investing $100,000 in 1950 according to this game plan. 

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