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The Sell In May And Go Away Trading Strategy


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Sell In May And Go Away Is a Trading Pattern Worth Knowing

Sell In May And Go AwayOne of the most common trading patterns in the stock market is known as “sell in May and go away”.  It is a phrase that is based on the fact that many savvy stock traders sell a portion of their holdings in May and go away for the summer to focus on leisure, instead of the stock market.  In reality, “sell in May and go away” represents a seasonal trading pattern in which the stock market tends to provide lower returns during the months of May through October.  Many traders use this seasonal weakness to book profits in May and buys back stocks when the stock market is lower over the following summer and early fall months.  However, “sell in May and go away” does not always work, and therefore, it is important to look at what is driving the stock market, beyond seasonal factors.  It is also not suitable for all traders and any tax implications should be fully understood.

How The Sell In May And Go Away Trading Strategy Works

Sell in May Monthly ReturnsA statistical analysis of monthly stock market returns over many decades confirms that on average the months of May through October yield lower stock market returns than the months of November through April.  In fact, below average stock market returns from May through October were found to be statistically present in thirty six out of thirty seven stock markets in a study done by the American Economic Review in 2002.  This is a stock market pattern that traders need to pay attention to in order to maximize annual trading gains.

Although the stock market may gradually rise during May through October if conditions are favorable, the returns are usually less robust than the other six month period of the year, which means money may be earn better returns if invested elsewhere during the May through October months.  This is especially true during times when cash investments pay decent rates of return.  Additionally, almost all of the significant stock market crashes have occurred during the months of May through October, with September and October being particularly difficult times for the stock market historically.  This means that traders that sell in May and keep a cash position into October, can take advantage of any stock market crash that develops during the early fall.  For a stock trader, entry and exit points are very important, and can mean the difference between annual gains and losses in a given trading year.

Here is how the “Sell in May and go away” strategy works in the real world.  Traders exit stock positions while the stock market is strong during the month of May.  Traders then lay low during the summer months and stay in cash or invest their money in fixed income securities.  They then look to reenter the stock market by late October; hopefully at lower prices than they sold in May.  Since November through April are traditionally the strongest months for stock market returns, traders want to be fully invested during these months.

Why The Sell In May And Go Away Trading Strategy Works

Sell In May Strategy
There are several reasons why the “Sell in May and go away” strategy works.  The main reason is that as the as the first quarter earnings season comes to an end, any rally that begins in January typically reaches an overextended state by May.  The last flurry of fresh money that comes into the stock market from tax returns dries up in May, and the stock market is left in a precarious position after over four months of rallies since the beginning of the year.  With the market in an overextended condition, any negative financial or geopolitical news can send it spiraling lower.  Negative news, in the form of geopolitical events, tends to hit the market more during the warmer summer months, than the cold winter months.

By late October, with the third quarter earnings season under way, stock market participants start to value stocks based on the following year’s earnings projections, which tends to cause stocks to rally when earnings projections are improving.  It is the upcoming new year’s earnings projections and fresh money injected into the market after the new year that causes the months of November through April to outperform May through October.

Why Sell In May And Go Away Might Not Work This Year

Due to a number of factors that affect the stock market, the “sell in May and go away” stock trading strategy does not always work.  The stock market’s direction is ultimately determined by the future outlook for the economy and corporate earnings.  In a year such as 2014, in which first quarter Gross Domestic Product (GDP) was greatly reduced by severe winter weather, a pick-up in second quarter GDP and corporate earnings could propel the stock market higher during the summer months.

Other factors that could cause the stock market to rally during the summer of 2014 include an improving European economy and a recovery in developing market economies.  In a year like this in which the stock market might make gains during the summer months, a prudent “sell in May and go away” strategy is to just sell a small portion of stocks held in a trading account, in case there is a summertime stock market dip, due to a black swan event.  Potential black swan events to look out for during the summer of 2014 include a Russian invasion of eastern Ukraine and an attack on Iran’s nuclear facilities.

Why Sell In May And Go Away Is Not Suitable For All Situations

The “sell in May and go away” trading strategy is best suited for traders that are willing to put the money they pull out of the stock market in May into fixed income  investments that earn a decent rate of return until they are ready to buy stocks again in October.  If one is an investor, there is no point in selling in May and buying back in October, because any capital gains from the stock sales for stocks held under one year will be recorded as regular income for tax purposes.  The tax liabilities will likely far outweigh any gains made by selling in May and buying back into the stock market in October.  Using a tax-deferred trading account, such as an Individual Retirement Account (IRA), is one way to avoid tax liabilities when implementing the “sell in May and go away” trading strategy.

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