With the first quarter of the year having come to an end, and as we enter the month of May, the old adage comes to mind – “Sell in May and Go Away.” But to separate ourselves from the herd, it’s important to get a better understanding of what this famous saying actually means.
In investment terms, the month of May is associated with a slow-down in the markets. Historically, going back to the 1950s, the markets figures have usually been weaker from May through to October than they have from November through to April.
According to general consensus, the most widely accepted reason for this is that most brokers go away over the summer period and lighten up their portfolios so they can concentrate on their holidays. Hence the very literal meaning in the saying; “Sell in May and Go Away.” But is this really the true reason, who knows?
Unfortunately for us, the strategy of deciding what to do with our portfolios is a little more sophisticated than basing it around broker’s holidays.
The Argument For “Sell in May and Go Away”
Within the industry it tends to be common practice to follow this adage, and the argument preached is that the figures are stacked up against you if you don’t. If you go against it, then it’s quite possible to end up on the wrong side of a trade. At least from a historical point of view anyway.
To get more clarity on this, let’s take a look at Figure 1 and Figure 2 below of the S&P500 Index from last year. If you had bought the S&P500 on the open of the first day of May 2012 and sold it on the last day of October 2012, you would have made a meagre 1.03% return.
Inversely, if you had bought the S&P500 on the open of the first day of November 2012 and sold it on the last day of April 2013, you would have made a decent return of 13.11%.
Quite a compelling argument to “Sell in May and Go Away,” isn’t it? Unfortunately, the above figures are not the same result every single year. If they were, then making money in the markets would become predictable.
The Argument Against “Sell in May and Go Away”
Good trading strategies are not as simple as making decisions based on historical trends. Decisions need to be made on what is actually happening in the markets right now.
If we examine past results, and look at the apparent poorer performing months of the “Sell in May and Go Away” adage (May – October), we will see quite a different picture.
By examining Figure 3 below, over the last 33 years displayed there have only been 11 years where May has had negative figures. June has had 16; July 18; August 13; September 18; and October 11. Although some of these are worse than the other months (November – April), the adage “Sell in May and Go Away,” alone, is not a good enough reason to close positions during this period.
For example, if the S&P500 was bought in November 1987 (an apparent safe month), then the end of month result of -8.51% would have come as a nasty shock to one’s portfolio. Or even, January 2009 (-8.54%) followed by February 2009 (-10.69%).
So What to Do?
Should all trades be closed out during the “Sell in May and Go Away” period? Or is it best to only close out certain positions? Do we just hold on and see what the markets do? The reality is these are the exact questions that need to be asked.
As mentioned earlier in the article, it is imperative to take a look at the current state of the markets and perform an analysis to determine the best course of action. The ability to read the markets is a crucial step in successful portfolio management, and it is something that most traders often overlook.
At Trade View Investments we concentrate on using mathematically based trading systems to perform such analysis. The figures that we look at are based on the Opening and Closing levels for the month, as these are tradable figures and the most relevant.
Why is this so important?
Opening and Closing prices for each month are more quantifiable figures compared to High and Low figures, and as such, traders will only know the true High and Low figures after the month is completed. Opening and Closing figures exist at the start and end of the month, so trader’s can use these figures more accurately to determine the probability of the direction of the market for the month.
Referring to Figure 3 again, each cell in the table shows the % difference between the Open and Close of the S&P500 Index since 1980 for each individual month (Lows and Highs are not considered nor is compounding).
If you think that the month of May will be a down month (based on the “Sell in May and Go Away” adage), and you decide to sell (short) the S&P500 on the first trading day of May and then buy (close) it back on the last day of that May, then you may get result similar to the one below. But this result is obviously not a guaranteed result.
The issue with this strategy is that sometimes the market overextends a rally or fall, so it’s possible that you may need to close a trade earlier than anticipated, which could potentially result in larger losses than expected.
An example of this can be seen by referring to the month of May in 2009. Here we would have expected the market to go down, but we were faced with a rally that month of 5.32% which completely goes against the adage and strategy.
Another example is if you decided to only sell (short) in May from 1985 – 1997 then every month would have been a losing month.
A method to make this strategy less risky is to take away the volatility by trading a closely correlated product at the same time, like the DOW 30 Index. This methodology is also known as “hedging”.
So in the context of this example, where we have the belief that the month of May will be down, we could buy the DOW Index to cover our short position in the S&P500. This hedges our position.
It is however, important to note that the risk of using this method is that the movement on one market (DOW 30) may not be enough to cover the movement on the other market (S&P500). There is no certainty of a guaranteed positive outcome, but it is still a useful tool if used correctly.
The flip side of this scenario is a Buy and Hold type investor whose strategy is to ignore the “Sell in May and Go Away” adage, and simply maintain a long (buy) position irrespective of such historical trends. This investor may still choose to hedge their position as a means of reducing risk by covering the portfolio with certain financial instruments such as Index Futures and or Options.
These examples are for illustration purposes only and not to be taken as advice as there are more complex and technical reasons behind them that are not discussed in this article. We discuss what these reasons are in our Trader Development Workshops.