Wednesday, November 24, 2010

The Holiday Effect

Well, it is now 12:30 on Wednesday November, 24th. It is the day before Thanksgiving and very likely 90% of traders are at home anticipating one of the biggest party nights of the year. Total volume on the day is ¼ of the usual total volume on a regular trading day. And the S&P 500 is up 1.3%, or 15 points, on the day. Of course that makes total sense with the latest news out of Korea, the ongoing European struggles with insolvency, insider trading probes conducted at large hedge and mutual funds, etc…

Yesterday, the market was down on huge volume. Traders unloaded stock because they did not want to be long going into this holiday weekend due to all of the reasons mentioned above, and many more reasons unnamed. With the absentee level extremely high and a huge sell off yesterday, the few determined traders working could drive the market higher today creating a short-term trading opportunity. The market has gained back nearly the entire loss from yesterday!

This is a phenomenon called Pre- Holiday Trading, which has been documented in academic literature. In 1988, Lakonishok and Smidt (and many others after them) examined stock returns on trading days directly preceding holidays. They used 100 years of data and found a strong pattern of high stock returns the day before the nine stock exchange holidays. Short-term traders would purchase stock on the preceding day and sell the day following a holiday. There are also other trading strategies using holidays as an entry point including purchasing before Christmas and selling at year end. These strategies have shown very strong gains and are clear examples of seasonality.

We have written on seasonality in past blogs but I thought this was a very timely and clear example. Certain human behavioral patterns are present in the stock market including calendar behavior. At Pinnacle, behavioral study and cycle analysis is just a small part of the overall process. But perhaps knowledge of all investment theory will lead our own investment process to a much more profitable place in the future. We just have to remember to sell on Friday!