There are plenty of old Wall Street adages that have been passed down for decades and are often referenced by traders and in the media. One of the more popular rules of thumb that tends to come up this time of year is “sell in May and go away.”
Smart traders know that just because a strategy is popular doesn’t necessarily mean its profitable. Here’s a closer look at what it means to “sell in May” and whether or not the strategy works.
The idea behind “sell in May” is extremely simple, which should probably be a red flag right off the bat. The trade is based on the idea that trading volume tends to die down during the summer months and U.S. stocks tend to underperform. To counter that trend, the “sell in May” crowd dumps stock holdings at the end of April and doesn’t buy back in until the end of October.
From 1950 to 2015, the Dow Jones Industrial Average gained an average of just 0.3 percent annually from May to October, but it gained an average of 7.5 percent annually from November to April.
At first glance, those numbers may seem to validate the “sell in May” trade. However, a breakdown of the month-by-month historical returns of the S&P 500 clouds the picture.
According to Yardeni Research, the S&P 500 has produced an average return of -0.1 percent in the month of May since 1928. In addition, the month of September has been by far the worst month of the year return-wise. The S&P 500 has averaged a -1.0 percent decline in September over the past 90 years.
However, the month of July has been the best month of the year for the S&P 500, which has gained an average of 1.5 percent during the month. In addition, the S&P 500 has averaged a 0.7 percent gain in June and a 0.6 percent gain in August, roughly average monthly returns for the index.
Sure, there may be some historical justification for the “sell in May” trade, but there’s no clear evidence that the underperformance during those six months is anything other than coincidence. Last year is a perfect example. The sell in May crowd missed out on an 8.1 percent rally in the S&P 500 from the end of April to the end of October. The S&P also gained 2.2 percent during the same stretch in 2016, 7.1 percent in 2014 and 10.2 percent in 2013.
In other words, the “sell in May” trade has not worked in four of the past five years. Even if there was a real pattern to play in years past, these types of patterns tend to disappear over time as more and more traders become aware of them and counteract them by attempting to time them for profit.
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