Santa Claus Rally In The Stock Market

Santa Claus Rally In The Stock Market

Christmas Day is one of the federal holidays in the US. But how does it affect the US financial markets? Is there a Santa Claus rally in stocks? Can we develop trading strategies for this holiday season?

Our trading strategy backtests reveal that there is a Santa Claus rally in the stock market. The stock market shows significantly better performance during Christmas and the days leading up to the new year. The Santa Claus rally is no myth or fiction.

Let’s go on to backtest this trading strategy and holiday period:

The Christmas holiday

From about 1840, celebrating Christmas became more widespread around the world, but it wasn’t until 1870 that December 25 was declared a federal holiday in the United States. Since then, Christmas Day has always been a federal holiday in the US.

The day is often celebrated with festivities ranging from fireworks and concerts to more casual family gatherings and exchanging gifts.

Santa Claus Rally in Stocks

Is the day before Christmas or after Christmas a trading day?

Christmas Day is not a trading day for all US markets, but the day before and after can be trading days, depending on whether they fall on a weekend. The day before or after Christmas is usually a trading day if Christmas Day falls on a weekday.

However, on the trading day preceding Christmas Day, the bond market closes earlier than usual and closes at 2 PM.

What happens if Christmas is on a weekend?

If Christmas Day is on a weekend, the Christmas federal holiday will be observed on the preceding Friday (if Christmas Day is on a Saturday) or the following Monday (if Christmas Day is on a Sunday).

The Santa Claus rally in stocks

In the rest of the article, we look at the Santa Claus Rally in stocks and the stock markets, the turn of the year effect, or simply the Christmas effect. It turns out that the second half of December is a very good month for stocks!

The Santa Claus rally in stocks – trading strategy backtest 1

The strategy is pretty simple and we make the following trading rules:

Trading Rules

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Let’s test if the hypothesis is true.

How has the stock market performed? Below is the equity chart of the S&P 500 from 1960 until today (100 000 invested in 1960 and compounded/reinvested):

Christmas rally for stocks
Christmas rally for stocks

The strategy has produced 0.7% per trade, the win ratio is 66%, the average winner is 2.1%, the average loser is -2%, the profit factor is 2, and max drawdown is 9%.

In other words, it clearly exists a Santa Claus market rally in stocks, but it seems like the best days were a few decades earlier.

The returns are substantially higher than any random seven-day period:

The backtest shows a CAGR of 0.7% while only being invested 2.3% of the time.

The performance was recently weak with three losing years in a row: 2013/14, 2014/15, and 2015/16.

The Santa Claus rally in stocks – trading strategy backtest 2

Let’s test another twist to the hypothesis and increase the holding period:

  • We enter at the close on the Friday prior to the options expiration week in December;
  • We sell at the close of the third trading day of the new year.

This returns the following equity curve:

Santa claus rally
Santa Claus rally

The strategy has produced 1.6% per trade, the win ratio is 72%, the average winner is 2.98%, the average loser is -1.8%, the profit factor is 4, and max drawdown is 11.7%.

This backtest period includes Christmas day, and we can safely say there is a Santa Claus rally in the stock market.

The Santa Claus rally in the stock market – trading strategy backtest 3

Let’s make a twist where we go long at the close of the first trading day after the 20th of December and sell on the first trading day of the new year. This backtest is just a small change compared to Santa Claus rally backtest number two.

The backtest in Amibroker yields this equity curve since 1960:

Santa Claus effect in the stock market
Santa Claus effect in the stock market

The average gain is 1%, the win ratio is 67%, the profit factor is 4.5, and the max drawdown is 5.9%. These are pretty solid results!

Why is there a Santa Claus rally?

One reason could be an injection of funds into the market. Mutual funds need to rebalance to account for accounting and tax issues, and at the same time, there is very little macro news during this time of year. When there is a vacuum of news there is less to worry about and prices tend to go up.

However, we also have to factor in that the turn of the month has, in general, shown a very positive effect.

Moreover, most people are on holiday and enjoying their time and see no clouds on the horizon. Thus, there are few reasons to sell stocks unless you get a higher price.

The Santa Claus Rally In DAX And Euro Stoxx 50

In this section, we look at the Santa Claus Rally of the German DAX and Euro Stoxx 50 indices. 

Our backtests show significantly better performance during the Christmas season and the end of the year. The Santa Claus rally is no myth in Europe, either! The Santa Claus rally in DAX40 and Euro Stoxx 50 is alive and well.

Instead of backtesting the local DAX futures contract, we backtest the ETF that tracks German stocks: EWG. The ETF is very liquid and has a history back to the late 1990s, and is thus one of the oldest ETFs still trading. 

Please keep in mind that the results might be different if you trade (or backtest) the DAX futures contract!

We backtest the Santa Claus Rally like this:

Trading Rules

THIS SECTION IS FOR MEMBERS ONLY. _________________ Click Here To Get Access Click Here To Get Access To Trading Rules

The Santa Claus rally in German stocks (DAX?)

This is the equity curve for EWG:

The average gain per trade is 2.1%, the win ratio is 81%, and the profit factor is 13(!). However, we can see that the returns have gone down over the last year (this is a log chart showing the relative differences). 

The Santa Claus rally in Euro Stoxx 50:

Let’s look at the Euro Stoxx 50 index. For this backtest we use the ETF with the ticker code FEZ. This one goes back to 2002 and is pretty liquid. 

This is the equity curve in Euro Stoxx 50:

The average gain per trade is 1.5%, the win ratio is 81%, and the profit factor is 9(!).

Just like DAX and EWG, we can see that the returns in the last 6 years were way below the average of the prior 15 years.

The positions are held on average for about 6-10 days. If we enter the position one week earlier, the holding period increases but the returns also go up, at the price of more volatile earnings. 

Santa Claus rally in DAX and Euro Stoxx 50 – Conclusion

The performance over the Christmas period is significantly better than any random period during the year. The average gain for any random week for DAX 40 is 0.12% and 0.18% for Euro Stoxx 50 (for comparison).

Thus, we can safely conclude there has been a Santa Claus Rally in DAX 40 and Euro Stoxx 50. That is, of course, no guarantee it will continue in the future!

We backtest the Santa Claus Rally in Emerging Markets

We did the following:

To get a longer time frame in our backtest we used Fidelity’s Emerging Markets Fund as a proxy. The fund has daily quotes and can be downloaded from Yahoo!finance. The ticker code is FEMKX and has data back to 1990.

The backtest was done like this:

  1. We go long at the close of the second Friday in December.
  2. We exit at the close of the first trading day of the new year.

We invested 100 000 the first year and compounded by reinvesting 100% of the equity the following years. The backtest returned this equity curve:

The average gain per trade is 2.7%, the win ratio is 73%, the profit factor is 6, and the max drawdown is 7%.

We have had many observations and it seems pretty obvious that we have a strong seasonal period in the form of the Santa Claus Rally in Emerging Markets, but it has vaned recently.

We backtest the Santa Claus Rally in NIFTY (India)

We did the following:

We downloaded the daily bars of the NIFTY 50 benchmark from Yahoo!finance. The index represents the weighted average of the 50 largest Indian companies. The index has, of course, derivatives contracts – both options and futures. The futures contract is one of the world’s most liquid.

The backtest was done like this:

Trading Rules

  1. We go long at the close of the third Friday in December.
  2. We exit at the close of the first trading day of the new year.

We only had data back to December 2007 and thus the number of observations is a low 14.

If we invested 100 000 the first year and compounded by reinvesting 100% of the equity the following years, we get this equity curve:

The backtest period is from 2008 until today. We backtested the NIFTY cash index, and this one is not a tradable index and should only be looked upon as a proxy. 

The average gain per trade is 1.2%, the win ratio is 71%, the profit factor is 6, and the max drawdown is 7%.

It seems like the Santa Claus Rally in NIFTY is no myth, either.

Amibroker code for the Santa Claus rally in the stock market:

If you’d like the Amibroker code for the strategy, please order the logic and code for all our 60+ free trading strategies on this website:

A somewhat similar seasonality exists on other exchanges:

Holiday effects in the stock market

We have covered all the US stock market holiday effects in trading. To sum up, we have the following other holiday effects in the US markets:

The End Of The Year Rally In Stocks (Santa Claus Rally/Effect) – conclusions

Most holiday periods show positive performance, but none is better than the end of the year or during Santa Claus. The end-of-year effect and Santa Claus Rally in the S&P 500 is no myth!

FAQ:

– How does Christmas Day affect the US financial markets?

Christmas Day is not a trading day for all US markets, but the days before and after can be, depending on the day Christmas falls on.

– What is the Santa Claus rally in stocks?

The Santa Claus rally refers to the end-of-year rally in stocks, occurring in the last days of December and the first days of January. It is sometimes called the turn of the year effect or Christmas effect.

– What is the turn of the year effect in stocks?

The turn of the year effect, also known as the Santa Claus Rally, is a phenomenon where the stock market tends to perform well in the last days of the year and the first days of the new year.

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