Tax Day Trading Strategy (Rules, Backtest, Facts, Effect)

Let’s look at the tax day trading strategy because most US taxpayers have a deadline on the 15th of April to file their tax returns. If the date is on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day. Does Tax Day signal any bullish or bearish trading signal? Does Tax Day affect the stock market? Let’s backtest a Tax Day trading strategy and find out:

Considering that April has been a very strong month for stocks for over 50 years, we argue that Tax Day doesn’t signal any particular bullish or bearish signal. We backtested the two weeks prior to Tax Day and the two weeks after Tax Day. However, Tax Day itself offers slightly stronger returns than any random day.

What is the US tax day?

The US Tax Day generally falls on the 15th of April, unless this is a weekend or holiday. For example, in 2022 Tax Day was on the 18th of April because the 15th was Good Friday and thus a non-trading day. The only exception is in the state of Massachusetts where they get an additional day to file due to their local Patriots Day.

Why should Tax Day affect stocks?

The stock market is influenced in the long term by valuations and future estimations of the earnings, but in the short run, it might be heavily influenced by capital inflows, capital outflows, and seasonality (for example). There could be a zillion reasons for why the stock market goes up or down (and that’s why news in trading is mostly noise).

Below is just two examples of why Tax Day could affect the stock market:

• It gives incentives to realize losses to offset gains in other stocks.
• Investors and traders might take out capital from the markets to pay taxes.

Tax Day trading strategy 1: Stock market performance prior to Tax Day

April is historically one of the best months of the year (read for a summary of the best month in the stock market). However, the returns in the first two weeks of April are substantially better than the last two weeks.

First, let’s look at the performance leading up to Tax Day deadline:

• We buy at the close of March, and we sell on the 15th of April or the next trading day (sell at the close).

Since 1960, the return in the S&P 500 looks like this:

This is a decent equity curve (what is a good equity curve?). The average gain is a respectable 1.13% and the trading win rate is 65%.

It turns out that the first two weeks of April are, by far, the best first two weeks of any month of the year. Below shows the returns when you buy at the close of the month and sell on the 15th of the next month (or the first trading day after the 15th):

The first column shows the month. For example, 3 means we buy at the close of March and sell on the 15th of April (thus number 3 is April and 12 is January). As you can see, April is the best month!

Tax Day trading strategy 2: Stock market performance after Tax Day

Let’s backtest stock market performance for the rest of April after Tax Day:

If we enter at the close of the first trading day after the tax file deadline and sell at the close of April, we get this equity curve:

The average gain per trade is a moderate 0.33% and the win rate is 60%. It’s substantially worse than the days up to Tax Day.

The table below contains the gains of every month if you buy at the close of the 15th (or the first trading day after) and sell at the close of the month:

April is in the 4th row, and four other months show better performance. The best month is December due to the Santa Claus Rally.

Keep in mind that the performance in April might also be influenced by the options expiration week effect and the week after options expiration day.

Tax Day trading strategy 3: The returns on Tax day

We like overnight trading strategies, and thus let’s check the performance of buying at the close of Tax Day and selling at the close the next day. This is what the cumulative returns look like:

The average gain per trade is 0.06% and the win rate is 53%. This is slightly more than the average gain of 0.04% per day which is the average over the last three decades. However, Tax Day has worked pretty good since 1995.

Does Tax Day affect the stock market? Conclusions

April is a very strong month for stocks, but it’s hard to tell positively or negatively how or if Tax Day affects the stock market. It might as well be other seasonality that makes this a strong month, one of them being the options expiration effect.

FAQ:

Does Tax Day signal any specific bullish or bearish trading signals in the stock market?

Tax Day in the United States is the deadline for individual taxpayers to file their federal income tax returns. It typically falls on the 15th of April, unless it’s a weekend or holiday. If the 15th is a non-trading day, the deadline is extended to the next business day. No, Tax Day doesn’t inherently signal specific bullish or bearish trading signals. However, the content suggests a backtested Tax Day trading strategy, analyzing stock market performance before, after, and on Tax Day itself.

How does the Tax Day trading strategy perform leading up to the deadline?

The strategy involves buying at the close of March and selling on Tax Day. Since 1960, the S&P 500 has shown positive returns with an average gain of 1.13% and a 65% win rate during the first two weeks of April. Post Tax Day, entering at the close of the first trading day after the tax filing deadline and selling at the close of April resulted in a moderate average gain per trade of 0.33% with a 60% win rate.

Why might Tax Day influence stock market behavior?

Tax Day may influence the stock market due to factors like incentives to realize losses, offsetting gains, and investors or traders withdrawing capital to pay taxes. However, the stock market is influenced by various factors, and Tax Day is just one potential influence. The performance in April could be influenced by other seasonal effects, including the options expiration week effect and the week after options expiration day.