Last Updated on October 16, 2021 by Oddmund Groette
The year has four different seasons and the financial markets have seasonal patterns as well. If you are looking for a trading edge in the markets we believe seasonalities can offer you some strong and long-lasting edges. Many of them can’t be used on their own, but together with other parameters, seasonalities are a great trading tool.
This article looks at why you should use seasonalities in trading (seasonal patterns). We explain what seasonality trading is, why seasonalities happen, and at the end, we give a list of seasonalities in stocks and how to use them.
What is seasonality in trading?
Seasonality refers to patterns that occur at regular intervals in certain time frames. The study of time series data in many different assets shows that each asset has its own peculiarities or seasonalities from time to time. Perhaps the best well-known seasonality was the January Effect in stocks: stocks tended to rise in January.
Does a seasonal pattern happen with certain regularity?
No, a seasonal pattern doesn’t happen with 100% regularity. We are talking about statistics and averages.
The averages might indicate stronger performance during the winter than in the summer, for example, thus we have a seasonal pattern. It doesn’t mean we witness positive returns every winter, though. Even though a pattern can have a very positive average, it could be the result of outliers. If you have few observations to back the seasonality even 2-3 observations can explain most of the result. The win ratio in trading is important.
No seasonal pattern lasts forever. The above-mentioned January Effect was one of the most useful seasonalities until it stopped working. Stocks performed very well during the month of January for many decades until the 2000s. This pattern has dissipated over the last two decades.
An example of seasonality in gold
As an example, we can look at how gold has shown strong performance in January and August since 2006. The table below shows each month’s performance for GLD (the ETF that tracks the gold price):
Intraday seasonality in stocks
Another example of seasonality is the intraday movement in stocks. We can break down the trading day into three separate sessions: the opening session (1 hour), the midday session (many hours), and the closing session 30 mins to one hour). The volatility is different from each session: the midday session is calm while the two others have much more action.
Why use seasonalities in trading
Understanding seasonalities is important in trading. Why is that?
The main reason for studying seasonalities is that we believe most of the anomalies you find in your backtests are camouflaged seasonalities. For example, the Turnaround Tuesday is mostly a result of a seasonality – not an anomaly. Where you see correlation in trading, it might just be a hidden seasonality.
Another reason for using seasonalities in trading is that they can be very valuable inputs into strategies by combining other parameters.
We use seasonalities extensively in our research and live trading, at least in our stock trading. The reason is simple: we believe most of the edges are structural and thus more likely to last year after year. For example, the turn of the month trading strategy is most likely a result of behavioral patterns, this we like to refer to it as a structural trading edge.
Drawback with seasonalities
One drawback with many seasonal patterns is the number of observations or the lack of observations. Noise and randomness are lurking at every corner in the financial markets, and you must be careful to conclude prematurely. An annual pattern obviously happens just once a year, and hence you need 30 years just to get 30 observations. This doesn’t hold up in any statistical test.
A general rule in trading is to have as many observations as possible. The very successful Medallion Fund only trades short-term patterns because they want a huge sample of observations. Keep this in mind when you are backtesting!
Another drawback is that markets are non-stationary. Nothing lasts forever. The same applies to seasonalities and thus you have to make up for losses in seasonalities that stop working.
- Why trading strategies don’t work in live trading (Why they stop working)
- Why trading strategies are not working (How do you know a trading strategy stops working?)
- How to avoid or minimize strategies stop working (Be prepared when your strategy stops working)
Why do seasonalities happen?
We’ll briefly explain why seasonalities happen, although many are hard to explain. Jim Simons’ Medallion Fund is careful to ask why too frequently because the market consists of an unlimited number of causes and correlations and is thus extremely complex to understand.
Seasonalities because of order flows
Let’s get back to the three daily sessions in the stock market: the open, the midday session, and the close. Why are the opening and closing sessions more volatile than the midday session? That is most likely because a larger portion of the order flow is happening around the opening and closing sessions.
Moreover, overnight news needs to be discounted and this might lead to further volatility for the opening session. We believe this is a structural seasonality and more likely to stand the test of time.
Seasonalities because of weekdays, holidays, and news
We see the same seasonal tendencies on Mondays which are more volatile than other days. Our hypothesis is that investors discount news after the weekend.
Thus, there is a structural reason why we see more volatility around the open and the beginning of the week.
Regulatory and legal seasonalities
When something is labeled as seasonalities we associate this with weather and climate. And for commodities, this might have huge impacts.
The commodity market, which is highly dependant on the weather, has many seasonalities. In the links below you can find some examples in three of them:
The Jobs Report is published on the first Friday of each month. This creates huge volatility in both bonds and stocks and has proved to be a very positive day for stocks over the last 30 years.
In a later article, we’ll cover this seasonality.
Practically all the gains in the S&P 500 over the last 30 years have come overnight from the close of the session until the open the next day. The S&P’s 10% annual return since 1993, including dividend reinvestment, has come from owning it overnight, and the day session from the open to the close has contributed almost nothing. This is an extremely strong seasonality!
We see the same pattern in gold miners (GDX): a strong drift upward overnight, while the day session is negative. Read more here about these patterns and how you can exploit them.
- Night strategies trading (overnight edges/strategies)
- 4 Overnight Trading Strategies In The S&P 500 (Strategies From Close To The Next Open)
Is it seasonality in stocks?
We have already mentioned in this article many seasonalities in stocks: the overnight edge and the increased volatility during the open and the close.
We trade mostly stocks and related indices. One reason for that is the many seasonalities you can find in both the broad indices and in subsectors.
For example, oil and oil stocks perform better in the first half of the year while many healthcare stocks have their best period during the summer when the overall market is weak. We’ll get back the latter seasonality later.
But there are many more. Below are just a few of the seasonalities we have covered and there are many more to clome (please register your e-mail in the right upper corner to get updates):
- Last trading day of the month trading strategy (the last day of the month effect/seasonality)
- The options expiration week effect (options week anomaly and seasonality trading strategy)
- Trading the holiday effect in stock markets (anomaly and seasonality)
- The turn of the month trading strategy (end of month effect)
- First trading day of the month trading strategy (first day of the month effect)
- The end of the year rally in stocks (S&P 500 Santa Claus rally/effect)
- What is the worst month of the year for stocks? It’s September
- Even Vs. odd days trading strategy (S&P 500)
You can find many more among our free trading strategies.
Summary of why use seasonalities in trading
Seasonalities are important to succeed in both trading and investing. Most of the anomalies you find in the markets are most likely camouflaged seasonalities. Keep this in mind and look out to use seasonalities together with other parameters (or the other way around).
Disclaimer: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinions – they are not suggestions to buy or sell any securities.