What Is The Santa Claus Rally and How Do You Trade It?
At the end of every single year, both traders and investors gear up for a unique phenomenon in the markets called the 'Santa Claus rally.' Over the years, there have been many different interpretations of this unique event in which the S&P 500 stock market index has averaged a gain of 1.6% with positive returns more than 75% of the time since 1969.
However, the most interesting part is that the phenomenon has also caused some very interesting seasonal based moves at the end of each year in other asset classes. This is why knowing what the Santa Claus rally is, why it works and how to profit from it is essential in ending the year strong! Read on to learn more. ▼▼▼
In this article, you will learn:
✅ What the Santa Claus rally is and the theories surrounding why it works!
✅ How this phenomenon affects stock markets, as well as other asset classes such as foreign exchange and commodities.
✅ The exact dates that define the Santa Claus rally period and how you can take advantage of the opportunities it presents.
✅ Why having access to the right products, markets and tools are essential in trying to capitalise from this 'once a year' unique event, including:
✔️ How to open a Trade.MT5 account to speculate on the price direction of multiple asset classes using Contracts for Difference (CFDs), so you can potentially profit from both rising and falling markets, while trading on margin!
✔️ How to supercharge the world's most popular trading platform, MetaTrader, with the exclusive Admiral Markets Supreme Edition plugin to access advanced trading tools and services like the Technical Insight Lookup indicator which provides you with actionable trading ideas on thousands of different markets!
✔️ How you can test all of the services provided by Admiral Markets UK Ltd and test your own trading ideas and theories completely FREE by opening a demo trading account!
✅ And much, much more!
What is the Santa Claus rally?
The Santa Claus rally is a term used to describe the seasonal tendency for the stock market to rally higher during the Christmas period. In the past, this tendency has also been called the Santa rally, December effect or Turn-of-Year effect.
The Christmas stock market rally also fits into the broader group of the Holiday effect. There are strong seasonal tendencies around all the major holidays for reasons that will become apparent when we look at the causes of the Santa Claus rally.
So when exactly is the Santa rally? Is it the whole of the month or just a few days of the month? To understand this phenomenon better it is important to understand the history of the Santa rally first and then look at the price chart of the stock market during this phenomenon!
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Santa Claus rally history
The first evidence to be produced regarding a stock market Santa Claus rally was in 1942 when S.B Wachtel presented it in the Journal of the Business of the University of Chicago. The analysis showed that there tended to be a rise in the stock market (using the Dow Jones Industrial Average index) from December to January from 1927 to 1942.
Since then, there have been many variations of the Santa rally, but the most popularised version and the one that still stands to this day is the research done by Yale Hirsch in 1972 and presented in the 1973 Stock Trader's Almanac. Hirsch discovered that the stock market rallied within the last five days of the year and the first two days in January.
The chart below shows the change in the S&P 500 stock market index during the last five days of the year and the first two days of January:
Source: CNBC, 24 November 2020
When it comes to analysing the Santa Claus rally statistics, it is clear to see that there is a tendency for the stock market to rally during this period of time. Of note was the Santa Claus rally 2018 which performed well. While 2014 and 2015 were down years, the average of the 2008 to 2018 period is still positive.
In a later section, we will go through different trading strategies to capitalise on this event. However, it's important to note that its founder, Yale Hirsch, would use this as a barometer of what could happen for the next year. In the newly released 2019 edition of the Stock Trader's Almanac, research showed that every year that Santa did not come to the market during this period of time, the next year suffered a bear market or a flat year.
This is interesting when looking at the Santa Claus rally 2019 period for the S&P 500 stock market index. In the chart below, the last five days of 2019 and the first two days of 2020 are highlighted between the two blue vertical lines. It shows that the market did initially push higher before moving back down with a big red candle on the second day causing the market to gap down and start the third day lower than where the market was at the beginning of the five day period in December.
Source: Admiral Markets MetaTrader 5, SP500, Daily - Data range: from 13 Nov 2019 to 5 Feb 2020, accessed on 24 Nov 2020 at 10:36 am GMT. Please note: Past performance is not a reliable indicator of future results.
From an opening to opening price perspective on the last five days of 2019 and the first two of 2020, Santa only turned up marginally, with price only slightly higher. The historical evidence would then suggest that 2020 would be a flat or bearish year. It was in fact, one of the most volatile years in history due to the coronavirus pandemic. But the interesting part is that there is something of a seasonal tendency during this period of time. Before going through how to trade the opportunity, let's first understand why this tendency happens.
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The causes of the Santa Claus rally
There are a variety of different reasons on why there is a seasonal tendency for the stock market to rally at year-end and over the Santa Claus rally's seven-day period. Some include:
▶️ Tax-loss harvesting is when investors sell stocks at a loss at the end of the year to offset capital gains tax. This means they are buying back their positions in the market causing weak stocks to rally higher which will naturally push up the strong stocks on momentum flows.
▶️ More people are also on holiday during this period of time which means many large institutional investors will not be at their desks. This could result in less active short sellers being present in the market, leaving long-only algorithms for mutual funds to keep buying the dips for investors' portfolios.
▶️ End of year bargain hunting also takes place as investors focus on what to put in their portfolios for the next year. This is why value stocks can have a tendency to outperform towards year-end as investors bank gains on growth stocks and put some back into value stocks which present a greater reward to risk over the long-term.
▶️ It could also just be a self-fulfilling prophecy! Traders and investors are always looking for an edge in the market. While year-end optimism, investing of bonuses or any of the other reasons listed above could explain the phenomenon it could also be because the tendency was first found in 1942! As it has been around for so long, investors anticipate it and react to it, thereby keeping the phenomenon intact!
Whatever the reason, it is there and important to know about. So what are the possible trading opportunities around it? Let's take a look! ▼▼▼
Santa Claus rally trading strategy
There are a variety of ways traders can take advantage of the Santa Claus rally. However, because the Santa Claus rally is over seven-days, it lends itself much better towards shorter-term strategies.
For the most part, the simplest method would be to buy on the first of the last five days of the year and then close out at the close of the second day of the New Year. The problem is where do you put a stop loss and how do you risk manage the position? While history shows the period averages a positive 1.5% gain, there could be some wild swings to the downside on some occasions.
Many traders may then decide to look at the seven-day period of the Santa rally on a lower timeframe and employ day-trading type strategies try to identify bullish price action patterns, or technical trading indicators to support buying during a period where history shows there is a tendency to have more buyers than sellers.
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The chart below shows the lower timeframe four-hour chart of the S&P 500 stock market index during the Santa Claus rally period in 2019.
Source: Admiral Markets MetaTrader 5, SP500, H4 - Data range: from 13 Dec 2019 to 14 Jan 2020, accessed on 24 Nov 2020 at 11:36 am GMT. Please note: Past performance is not a reliable indicator of future results.
The highlighted yellow box on the chart above shows an example of a popular candlestick trading pattern called an Inverted Hammer. It is a pattern that is usually found after a downtrend and one which traders would take as a signal for a trend reversal.
Traders could also add technical trading indicators to look for further clues of buying. In the example above, at the time of the Inverted Hammer the Stochastic Oscillator was below 20 which is considered oversold and where the market may push up.
In this instance, traders could simply have an entry one point above the high of the Inverted Hammer with a stop loss one point below the low. This would have resulted in a possible entry price of 3226.50 and a stop loss at 3211.15. If trading 10 lots, then this would result in a potential loss of -$153.50. If the trader targeted the next swing high point at 3251.54, this would have resulted in a profit of $250.40.
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Trading the lead up to the Santa rally
Some longer-term traders and investors may look at the period that leads up to the Santa Claus rally, as there is a seasonal tendency for stock markets to start rising from October. Below is a chart showing the average trend of the last 20-years ending in 2019 for the S&P 500 stock market index.
Source: EquityClock, 24 November 2020
This shows that there is a strong tendency for the stock market to rally from October all the way to the end of the year. This could be due to many reasons such as traders being more active in the market to end the last quarter of the year well, more optimism around the holiday period creating more revenue for different companies, etc. Whatever the reasons, the pattern is evident.
In this instance, traders may take a longer-term approach and start to build positions in stock markets from October to the end of the year. This could involve looking at the daily timeframe charts and utilising more of a swing trading style. For example, in the chart below the price bars in between the two bold vertical blue lines shows the activity of the S&P 500 stock market index from the beginning of October 2019 to the end of the year.
Source: Admiral Markets MetaTrader 5, SP500, Daily - Data range: from 16 Aug 2019 to 29 Jan 2020, accessed on 24 Nov 2020 at 12:36 pm GMT. Please note: Past performance is not a reliable indicator of future results.
During this period of time, the seasonal rally started right at the beginning of October and went all the way to the end of the year and beyond. As the market tends to rally during the end of the year and into the Santa Claus rally dates, both traders and investors may start to build positions in anticipation of higher prices. Some investors might be even more selective and look at different stock market sectors that outperform during this period of time to further identify high-probability investing opportunities.
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A screenshot showing an example of searching for 'S&P 500 Index' in the Trading Central Technical Insight Lookup indicator in the MetaTrader 5 Supreme Edition platform provided by Admiral Markets.
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How to trade the Santa Claus rally in four steps!
Once you have a potential trading setup, either through your own research and analysis or through the actionable trading ideas in the Technical Insight Lookup indicator, you can place a trade in just four steps, as shown below:
- Open your MetaTrader 5 trading platform provided by Admiral Markets, or start your free download here.
- In the Market Watch window (Ctrl+M), type in the instrument you want to trade and select it from the pre-populated list.
- Drag the symbol onto the chart and open a trading ticket by pressing F9, or using the right-click options.
- Fill in your stop-loss and take-profit levels, and volume amount, then either press Buy if you believe the market will rise or press Sell if you believe the market will fall. Done!
A screenshot showing the Admiral Markets MetaTrader 5 Supreme Edition trading platform with a trading ticket open on the chart, along with the Mini-Terminal feature.
Why trade the Santa Claus rally with Admiral Markets?
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✅ Begin trading on the popular online trading platform MetaTrader for PC, Mac, Web, Android and iOS operating systems, provided for free by Admiral Markets.
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About Admiral Markets
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.