First Trading Day Of The Month Trading Strategy (First Day Of The Month Effect)
Last Updated on July 7, 2022
There are many effects and seasonalities in the stock market. One frequently mentioned seasonality is the first trading day of the month effect. Is the first trading day of the month effect a myth or fact? In this article, we look at how the stock market (the S&P 500) performs on the first trading day of the month.
The stock market performs significantly better on the first trading day of the month compared to other days. Furthermore, we have developed two trading strategies based on the first day of the month effect.
Some of the other seasonal trading strategies are covered on our landing page of free strategies:
The first day of the month effect
Let’s define the first day of the month and look at its performance:
The first day of the month defined
First, we start by defining the first day of the month effect: we are referring to the first trading day of the month, and not the first calendar day. The first trading day of the month could be the third calendar day, for example, if the first calendar day is on a weekend or there is a holiday.
How the first trading day of the month effect performs
First, let’s test the average gain from the close until the next day’s close in the S&P 500, the broadest measure of the stock market, on any day:
The equity curve above shows the compounded result of 100 000 invested at the close and held until the close the next day. We used the ETF with ticker code SPY to perform the test. The average gain per day is 0.05%.
Thus, the stock market has a nice tailwind, something you also can turn into night trading or overnight strategies:
Let’s test by holding the S&P 500 (SPY) from the close of the last trading of the month until the close of the first day of the month:
The test is done by investing 100 000 in 1993 and let it compound all the way until May 2021.The result indicates a solid edge in owning stocks on the first trading day of the month:
The average gain on the first trading of the month is a solid 0.25% – five times better than the average day in the stock market. There obviously is a first day of the month effect.
Is this a tradeable strategy?
Unfortunately not. It’s far too unstable and unreliable to be traded. Furthermore, we see that most of the gains were up until the GFC in 2008/09.
Since then, the strategy has not worked so well, even though the average has been 0.17% per trade:
Is it any way we can improve the strategy? Luckily, yes.
The first trading day of the month – strategy number one
We still use the ETF with the ticker code SPY. However, you can of course use the S&P futures, the e-mini, or the recent micro contract.
Since 1993, there have been 341 different months. We inserted a very simple filter into the strategy and reduced the number of trades to 256. However, the average gain per trade increases to 0.35.
By doing this, the strategy is invested only 1.7% of the time but still returns 3% CAGR since 1993. The win ratio is 67%, the average winner is 0.82%, the average loser is 0.62%, the profit factor is 2.5, and the max drawdown is 5%.
We think these are pretty good numbers.
The above numbers are from the close of the last trading day of the month until the close of the first day. However, if you close the position on the open of the first day, the average is still a respectable 0.22% and has a profit factor of 3.7. The max drawdown is reduced to 3%.
The first trading day of the month – strategy number two
We also made another twist to the strategy: But this time we buy on the close on the first trading of the month given one criterion. The equity curve looks like this:
There are 49 trades (only) and the average gain per trade is 1.24%. The strategy is only invested 0.9% of the time but returns a CAGR of 2.11%.
Both of the strategies above will be presented as one monthly Trading Edge to our subscribers during the winter of 2021/22:
Why is there a first day of the month effect/tendency/seasonality?
We are traders and prefer to establish facts, and not “guess” why an effect or seasonality exists.
However, most the most likely reason for the positive bias on the first day of the month is an inflow of capital from savers, pension funds, automatic savings to 401s, etc. There simply is more capital entering the stock market and this creates a small tailwind and sellers can demand slightly higher prices.
Conclusion about the first day of the month effect
The first trading day of the month yields significantly better returns than any other day of the month.
Just buying at the close of the month and selling at the close on the first day of the month, is not a viable strategy in itself, but by adding one filter or one criterion the strategy can be improved a lot and used as a trading strategy in the S& 500 (or even Nasdaq).
Can you solve this please. I am in high school and I need to solve this in 2 hours. Please help
You and your friend Chirag are cult fans of cricket. However unlike you, Chirag is a compulsive
gambler and regularly bets on India in various matches and tournaments. India and England are
about to play a 5 match T20 tournament in March and Chirag is already pepped up about seeing
India win and making a lot of money. He wants to bet Rs. 25,000 on a double or nothing bet in
which he gets double the money if India wins the tournament, otherwise nothing.
Matches in T20 rarely ever tie so you may neglect the probability of a particular match ending in
a draw. Also both India and England are extremely strong forces in international cricket and
equally likely to win on any given day. Any team that wins 3 matches first wins the trophy.
Unfortunately for Chirag though, the bookie is taking bets on seperate matches only and not the
tournament as a whole. That means he can’t bet on the outcome of the entire tournament and
will have to place the double-or-nothing bets on individual matches itself.
Help Chirag to model how much money he should bet before each match of the tournament so
that in the end, he gets double his money (Rs. 50,000) if India wins the trophy and loses his initial
Rs. 25,000 if India ends defeated.