Home Trading indicators The December Low Indicator Strategy (Backtest And Performance)

The December Low Indicator Strategy (Backtest And Performance)

Many patterns or models try to predict what the performance of the market may be in any given year. For example, the January effect, presidential cycles, valuation models, etc. Today we will look at one that many traders do not usually know. It’s called the December low indicator strategy.

The December low indicator tries to predict the performance of the market in a year based on the lows of December and next year’s first quarter. It has proven to be a strong indicator of future performance worth implementing in our trading systems.

In this article, we will describe the December low indicator, compare it to the January effect, and backtest the trading strategy on the S&P 500.

We backtest trading strategies and systems frequently. If you are looking for a short term trading strategy, please click on the link (we have made hundreds of strategy backtests).

What is the December low indicator?

Lucien Hopper, a Forbes columnist and Wall Street analyst, originated the December low indicator in the 1970s. Hopper dismissed the importance of January and January’s first week as reliable indicators. He noted that the trend could be random or even manipulated during a holiday-shortened week.

Instead, said Hopper, pay much more attention to the December low. If that low is violated during the first quarter of the new year, watch out!

Comparison to the January Barometer

The January Barometer states that the performance in January determines the average gain for the next 11 months. If the close of January is higher than the close of December, the average gain is substantially higher the next 11 months than if the January close was lower than the

December close. We backtested this strategy before and determined that, although it is not bulletproof, it does pretty well.

They both try to predict the market performance for the rest of the year. The January effect does it taking into account the performance of January. The December low indicator does it by seeing that the December lowest level in the index is not breached during the first quarter.

The December low indicator – trading rules

The strategy, in other words, is: if the December low is violated during the first quarter, returns will be weak for the rest of the year. If it doesn’t go below the December low, good times could be coming. So, having this in mind, the strategy is pretty simple:

  • We buy the S&P 500 in April if, in the first quarter, the December low was not violated.
  • We sell it at year-end.
  • If the December low was violated in the first quarter, we would do nothing and stay in cash.

The December low indicator trading strategy – backtest

We started the backtest in 1970 using the cash index of S&P 500. The data is not adjusted for dividends and splits.

Here is the equity curve when we apply the trading rules:

The December low indicator strategy

The performance of the strategy looks pretty good! Here are some statistics and metrics of the strategy:

  • CAGR is 5.04% (buy and hold 7.54%)
  • Time spent in the market is only 39.37%
  • Risk-adjusted return is 12.8% (CAGR divided by time spent in the market)
  • Maximum drawdown is 30.17% (52.56%)

The December low indicator has generated 25 signals with an average gain per trade of 11.03%. Out of the 25 signals triggered, on only 3 occasions, the S&P 500 ended the year lower than in March. This means that the strategy has a win rate of 88%.

Furthermore, the drawdown is significantly reduced by 20 percentage points. The signal avoided the dot.com bubble in year 2000 and the financial crisis in 2008, among others.

The December low indicator strategy – conclusion

To sum up, the December low indicator strategy generates a strong signal about the future return of the S&P 500. It can also work as a validator of the January effect signal. Either way, it is valid, and it can help us improve our trading models.

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