19 December 2014

Should you believe in the Santa Claus Rally?

Could the so-called Santa Claus Rally give traders the gift of a 100+ basis point bump before the New Year? Here’s what you need to know.
​​​​​​​​​The term ‘Santa Claus Rally’ was coined by Yale Hirscher, founder of the Stock Trader’s Almanac, to describe a trend he identified; a tendency for the stock market to rally at the very end of each year. While it has been modified by some commentators to encompass the whole month of December, Hirscher’s definition refers to the last five trading days of the current year and​​ the first two of the New Year. 

What the data shows
The S&P 500 rose in 16 of the last 20 years during this 7-day period, according to Jeff Hirsch​, Yale Hirscher’s son and current editor of the Stock Trader’s Almanac. The average gain was 1.2% while the largest individual gain was 7.4% in 2009. Notably, the index experienced losses in 2000 and 2008, preceding some of the worst performing markets in recent memory.

The festive rally isn’t limited to US markets either. A quick review of the FTSE’s performance for the same 7-day period over 10 years shows a similar pattern, though it fell the Christmas before the 2008 financial crisis.

 
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Some consider the Santa Claus Rally to be a result of people buying stocks in anticipation of a rise in stock prices during the month of January, otherwise known as the January effect​. ​​Photo: Shutterstock 
What this means for traders
 
There are various explanations for this seasonal trend. Savvy buyers could propel the market by
loading up on shares in advance of what is known as the ‘January effect’, another seasonal trend
that suggests the markets tend to rise at the start of the New Year. Similar effects could be
experienced due to the relative lack of volatility increasing risk appetite or institutional investors
taking advantage of tax-​related selling of losing positions.​

3 tips for managing the Santa Claus Rally

1) Focus on equities: While the trend may affect the Forex markets, its greatest impact historically is on equities.
2) Monitor volatility: If volatility increases, market conditions may switch from favourable to ​unpredictable.
3) Manage risk: Don’t abandon your normal risk management rules just because of the increased probability of a rally.
The Santa Claus Rally may also act as an indicator for the year to come. Hirscher Sr coined the following Christmas jingle as a warning to traders:

‘If Santa Claus should fail to call, bears may come to Broad & Wall’

What this means is if the markets fall during this period, it may not bode well for the New Year.
Traders should watch closely for some hint of what to expect in 2015.

     

The value of your investments can go down as well as up.
Losses can exceed deposits on margin products.
Please ensure you understand the risks.

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The value of your investments can go down as well as up.
Losses can exceed deposits on margin products. Please ensure you understand the risks.