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4 Historical Rules Every Trader or Investor Should Know

Tom Bowley, Chief Market Strategist

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Historical Rule #1: RARELY Short from the 28th to the 6th of ANY month
Why? From January 1, 1950 to June 30, 2011, the S&P 500 had risen 8,176 days and fallen 7,174 days. So theres been a 53.26% chance of the market moving higher on any given day. During the 10 day period from the 28th to the 6th, encompassing 4,674 trading days, that ratio moves to 56.40%, making it riskier to short because the odds favor being long. I know what youre thinking. Why should I care that much about a 3% increase in the number of rising days? Well, theres more to it. Would you care to know the difference in annualized returns? Since January 1, 1950, the S&P 500 has posted AVERAGE annual returns of 8.77%. The AVERAGE annualized return for the 28th to 6th period is 24.88%! Let me put this another way. If you ONLY invested in the S&P 500 from the 28th to 6th every month, youd capture essentially the entire S&P 500 gain since 1950. Forget about the rest of the month, its a wash! Is this a fluke? NOOOO! Then why does it happen? Two reasons - window dressing and money flow. Theres a game on Wall Street amongst institutions. When they dont own great performing stocks during huge advances, they make it look like they owned them. Notice how mutual funds always disclose their holdings at month end? Well, if youre the lead manager of a mutual fund and you didnt own Apple, Inc. (AAPL) during a period when their price soared, you can sort of cover it up by window dressing. Essentially, you buy it at months end so that when prospective investors are eyeing your holdings, they notice you own AAPL and naturally they assume youre absolutely brilliant! The truth, however, is that you missed the boat and youre now chasing performance. Like I said, its a game. But think about what happens as mutual funds with LOADS of cash start buying performance as month end winds down. Where are the major indices likely to head? You guessed it HIGHER! From an annualized return perspective, the no-questions-asked, three best calendar days of the month, in terms of annualized returns, are the 1st (+49.59%), the 2nd (+40.11%) and the 31st (+39.38%). The early part of the month tends to benefit from money flows. If you work for a company and regularly contribute to your companys 401(k) plan, the company periodically (usually either once or twice per month) remits the retirement money collected to a mutual fund company like Vanguard. Companies like Vanguard dont really have the option of remaining in cash. When your employer sends them your 401(k) money, that money is immediately invested in the funds that you authorized. Much of that money is invested at the very beginning of the month and contributes to the market success during the period. Trying to short the market from the 28th to the 6th will certainly work on occasion, but understand youre definitely fighting an uphill battle!

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Historical Rule #2: Dont Go Away in May!!!
Why? As a student of history, this is the one that gets replayed over and over and over again. Every time I hear it, my stomach churns. Rather than listen to those who like to discuss something they have little or no knowledge about, let me provide you some facts. First, let me give credit where credit is due. Since 1950, May and June have had annualized returns of 2.79% and -0.47%, respectively, on the S&P 500. On the surface, you could simply go away and you wouldnt be missing much. A little more digging below the surface would actually reveal a different story, however. If you go back to historical rule #1, the 1st thru the 6th and the 28th thru the 31st have produced excellent results in May on the S&P 500 since 1950. Here are the numbers: 228 days higher, 168 days lower, 33.18% annualized return. Would you really want to go away during a period that produces those kinds of numbers? I sure wouldnt. In fact, I might want to be leveraged on the long side! Next, what about June? Lets again check out the 1st thru 6th and 28th thru 30th. 217 days higher, 178 days lower, 21.73% annualized return. Again, do you want to leave that kind of performance on the table? I dont! The real slogan should be Go Away in mid-July, but it doesnt have the same ring, does it? We cant sell any commercials on CNBC with that type of slogan. Gotta do better than that!!! Theres no doubt that the vast majority of May and June tends to be neutral to bearish, but blindly throwing out the entire month because it sounds good makes little sense. When it comes to the stock market, take most of what you hear with a grain of salt. CNBC, in particular, is interested in selling ads. At the end of the day, they are judged by selling ads, not by educating the public. Can you imagine if the next expert came onto CNBC and proclaimed Go Away in May! and one of the hosts shot back, What about early in May and late in May when the annualized returns are better than 33%, FOUR times the S&P 500s annualized return since 1950? Should we just ignore those? That would make my day. But it wont happen. CNBC is on auto pilot. Its unfortunate too, because market timing gets a bad name. If investors realized they could actually manage their own investments by a calendar SIGNIFICANTLY better than those trained on Wall Street, the game would be over. And this game is worth billions and billions of dollars. Where BIG money is involved, the game lives on!!

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Historical Rule #3: Traders Beware the Monday Blues!
Why? There couldnt possibly be a difference between Monday returns and the returns of the rest of the week, could there? Well, check this out and then decide for yourself. Since 1950 on the S&P 500, here is the number of up days and down days by calendar day of the week, followed by the percentage of up days: Mondays: 1437 vs. 1520, 48.60% Tuesdays: 1591 vs. 1531, 50.96% Wednesdays: 1760 vs. 1371, 56.21% Thursdays: 1654 vs. 1426, 53.70% Fridays: 1733 vs. 1325, 56.67% There is a definite bearish bias on Mondays. This isnt just what happened the last several Mondays or the past years worth of Mondays, this is SIX DECADES of Mondays! And if you think those percentages are skewed, check out the annualized returns by day! Mondays: -15.96% Tuesdays: +8.50% Wednesdays: +21.01% Thursdays: +9.94% Fridays: +17.50% That is some SERIOUS underperformance on Mondays over a 60 year period. I believe just about any statistician would tell you that six decades of daily performance is representative of a meaningful trend. The obvious question is WHY are Mondays so much worse historically? I dont know the correct answer for sure, but my educated guess would be that its a psychological issue. Who wants to be at work on Mondays? Most working people, including those on Wall Street, have weekends off. Going back to work on Monday puts a lot of folks in a bad mood. If youre in a bad mood, would you buy or sell stocks? That might also explain why Wednesday through Friday produce much better annualized returns. I know I like Fridays a whole lot more than I like Mondays! How about you?

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Historical Rule #4 Expect Weakness from the 19th thru the 27th:
Why? I dont know for sure, but I assume it probably has something to do with the fact that it follows options expiration week. If the market normally moves higher and most traders play calls instead of puts, then options expiration week, or the week after, could produce selling induced by market maker activity. Its just a theory. But heres a fact. The chance of the S&P moving higher during this 19th to 27th period is three percentage points lower than the chance of any day throughout the year. And its six percentage points lower than during the 28th to 6th period. More importantly, the S&P 500 produces NEGATIVE annualized returns from the 19th to 27th of 5.65%. Thats a MINUS 5.65%. Considering that the S&P 500s average annual return is 8.77%, that represents a bearish variance of more than 14 percentage points. You cant afford to ignore that, especially if youre trading to make money. I break the market down into four distinct periods within the calendar month as follows: 28th 6th: Bullish 7th 10th: Bearish 11th 18th: Bullish 19th 27th: Bearish To give you a better visual, consider where the S&P 500 was to start 1950 and how its gotten to where it is today:

S&P 500, on January 1, 1950: 16.66

Add points gained from the 28th 6th: +1543.76 Subtract points lost from the 7th 10th: -561.46 Add points gained from the 11th 18th: +970.75 Subtract points lost from the 19th 27th: -649.07

S&P 500, on June 30, 2011: 1320.64

Thats quite a ride! But if someone asks, Can you time the market?, make sure you point them to Invested Central!!!!

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