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For every sector there is a season: Identifying opportune times to trade stock market sectors

  • By Jeffrey A. Hirsch,
  • Wiley Global Finance WILEY GLOBAL FINANCE
  • Markets
  • Sectors
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Wall Street moves to a cadence governed by the passage of time, controlled by a calendar that is influenced by habitual human and cultural behavior. Recurring events such as the sector trade show schedule, options and futures expirations, tax deadlines, holidays, the opening and closing bell, weekly, monthly, quarterly and annual portfolio adjustments and restructurings all have an influence on traders and investors.

Markets, sectors, and even individual stocks have shown a tendency to post annual highs and lows around the same time every year. This cycle is known as market seasonality. Like crops, stock sectors have a growing season, a harvesting season, and a period where they may be fallow. Sector seasonality can be a valuable tool for improving trading and investing results. Below I will show you that sector seasonality undeniably exists and how I think it can assist you in identifying opportune times to trade.

Identifying sector seasonality

Sector seasonality was featured in the first 1968 Stock Trader’s Almanac, citing a Merrill Lynch study that showed that buying seven sectors around September or October and selling in the first few months of 1954-1964 tripled the gains of holding them for ten years. Over the years I have honed this strategy significantly and now devote a large portion of our time and resources to investing and trading during positive and negative seasonal periods for different sectors with Exchange-Traded Products (ETPs).

To begin the process of identifying sector seasonality, a reliable data source is needed. Over the years, individual sector-based indices have proven to work best and are readily available from numerous sources. One such example is the AMEX Oil Index (XOI). (Note: the XOI is an example index; it is not possible to invest in directly.) This is a price-weighted index consisting of the leading oil exploration, production and development companies that dates back to 1984.

In Figure 1, the 5- and 25-year seasonal pattern of this index has been plotted. From this chart it is clear that over the longer term, XOI typically posts its greatest gains from right around mid-December until late spring/early summer. This trend has been muted over the past five years due to the Great Recession and sluggish global growth, but it still appears on the 5-year pattern. Much of this move is the result of the higher demand for gasoline during the summer driving season. As long as there is a summer driving season, this pattern is highly likely to continue to reappear year after year.

Armed with the knowledge of this seasonality a trader or investor could look to buy individual stocks from the oil sector, an ETP or a mutual fund. When I trade a sector seasonality I first ensure that the sector and correlated stock or ETP is tracking the seasonality closely (it does not happen every year). Then I ensure that my fundamental analysis of the sector and stock or ETP supports taking a position. And, finally I will use some technical analysis and analyze the chart for a specific entry point.

Creating a sector index seasonality strategy calendar

Examination of twenty-one individual sector indices produced the seasonalities listed in Figure 2. This table specifies whether the seasonality starts or finishes in the beginning third (B), middle third (M) or last third (E) of the month. These Selected Percentage Plays are geared to take advantage of the bulk of seasonal sector strength or weakness.

By design entry points are in advance of the major seasonal moves, providing traders ample opportunity to accumulate positions at potentially favorable prices. Conversely, exit points have been selected to capture the majority of the move.

These major seasonalities were used to create the Sector Index Seasonality Strategy Calendar shown in Figure 3. Note the concentration of bullish sector seasonalities during the Best Six Months (November-April), and bearish sector seasonalities during the Worst Six Months (May-October).

JEFFREY A. HIRSCH is editor-in-chief of the StockTradersAlmanac.com and the author of The Little Book of Stock Market Cycles (Wiley, 2012). He is Chief Market Strategist of the Magnet AE Fund.

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Article copyright ©2012 by Jeffrey A. Hirsch. Adapted from the Stock Trader’s Almanac with permission from John Wiley & Sons, Inc. The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Fidelity is not adopting, making a recommendation for or endorsing any trading or investment strategy or particular security. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before trading. Consider that the provider may modify the methods it uses to evaluate investment opportunities from time to time, that model results may not impute or show the compounded adverse effect of transaction costs or management fees or reflect actual investment results, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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