According to new data, there is an 83% chance that the Santa Claus rally is real. Never heard of the phenomenon? Don't worry. In today's article we discuss what the Santa rally is, what causes it and how you can start trading it today.
What is the Santa Claus rally?
As the name suggests, the Santa rally is a term used to describe the tendency for the stock market to post positive results in the run up to Christmas and the New Year. While it doesn't happen every year, the statistics speak for themselves:
- In US indices, like the SP500 CFD, a rally in the last five trading days of the year and the first two in January has yielded an average 1.3% gain since 1950, with positive returns 75% of the time since 1969.
- The FTSE100 CFD, which represents the UK stock market, has risen 83.3% of the time in December. Its average gain has been 2.4% for the month since 1987.
Whether traders and investors believe in the seasonal tendency or not, one can't ignore that the probabilities are skewed in the favour of a rising market during the end of the year.
What causes the Santa rally?
There is no clear research on what causes this seasonal tendency towards the end of the year. However, here are a few theories on why the markets tend to rally in December:
- More people are on holiday. This means short sellers are away, leaving algorithms building long positions for investor portfolios.
- Investors buy more seasonal shares (retail, airlines, etc) in anticipation of a Christmas boost to earnings in the next quarter.
- Bargain hunting for cheap shares for the next year's portfolio.
- Fund managers rebalancing their portfolios. Often managers would dump shares that aren't working and reinvest in shares that are working for them.
- Investing Christmas bonuses.
Of course, it could just be a self-fulfilling prophecy. As many people know about the Santa rally, if they see markets moving higher they believe it is working and will also start buying. So, it could all be down to mass psychology of the market.
As we know, there is a tendency for stock market indexes to rise at the end of the year, but not a certainty it's important we use other tools to aid in our trading decisions. This could be using technical analysis tools such as price action and support and resistance levels.
How can we trade the Santa rally?
There are many ways traders can take advantage of these seasonal tendencies. Let's look at one possible way using the FTSE100.
Source: Admiral Markets MT5 Supreme Edition FTSE100, Daily - Data range: from 20 March 2017 - 18 October 2018 - performed on 4 December 2018 at 11:46 AM GMT
As you can see from the chart above, the FTSE 100 has been moving sideways, with big swings up and down for much of 2017 and 2018. However, we know there are some statistics we could use to our advantage, such as the fact the market has risen 83.3% of the time in December. It's not a certainty, but it is an edge.
Now let's look at December 2017 more closely.
Source: Admiral Markets MT5 Supreme Edition FTSE100, Daily - Data range: from 3 August 2017 - 9 May 2018 - performed on 4 December 2018 at 11:49 AM GMT
We can see that December 2017 did rally higher. Traders could have used simple price action patterns to trade off such as the engulfing chart pattern on 15 December 2017. This pattern is where one trading bar totally engulfs the previous day's trading range by penetrating the high and low.
Source: Admiral Markets MT5 Supreme Edition FTSE100, Daily - Data range: from 11 October 2017 - 27 February 2018 - performed on 4 December 2018 at 11:54 AM GMT
A possible entry could be on the break of the high of the bullish engulfing bar, at 7503, with a stop loss at the low of the bar, at 7431. If the trade triggered the entry and then hit the stop loss this would result in a 72 point loss which at 10 lots is a £720 loss. If the trade was closed at the end of the month, at 7698, it would have resulted in a profit of £1,950.
With December underway, how will you be trading stock market indices this month?
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