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Monthly trading patterns: Human behavior shapes market activity

  • By Jeffrey A. Hirsch,
  • Wiley Global Finance WILEY GLOBAL FINANCE
  • Technical Analysis
  • Trading
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Throughout the history of the Stock Trader’s Almanac the stock market’s performance has been examined on a yearly, monthly, weekly, daily, and half-hourly basis to uncover trends and tendencies. Nearly a half century’s worth of research has confirmed time and time again that the beginning, ending, and middle of months, weeks, and days have significance.

This should not come as a shock to members of the human race. We place a great deal of emphasis on routine, marking the start and finish of nearly everything in our lives. From the alarm clock that wakes us to mealtimes to monthly bill paying to birthdays and anniversaries, we are creatures of routine and habit. Sometimes beginnings are fraught, encountered with anxiety, sadness, and fear; other times they are merrily celebrated. Endings are the same.

This carries over to the stock market. After all, the markets are traded by people and even the computers we rely on so heavily have been programmed by human beings. Understanding the market’s usual daily, weekly, monthly, quarterly, and annual rhythms may help you make better investing and trading decisions. They may offer you the opportunity to ride the cycle when they present in typical form, or respond differently when other events trump historical patterns.

Monthly cash inflows into S&P stocks

For many years, the last trading day of the month plus the first four of the following month were the best market days of the month. This pattern is shown in Figure 1, where from 1953-1981 the S&P 500 shows these five consecutive trading days posting gains a much larger percentage of the time than the other 16 trading days of the average month. The rationale was that individuals and institutions tended to operate similarly, causing a massive flow of cash into stocks near beginnings of months.

“Front-running” traders took advantage of this phenomenon, drastically altering the previous pattern. Figure 2, which follows the S&P 500 from 1982 onward, shows the trading shift caused by these “anticipators” to the last three trading days of the month plus the first two. Another astonishing development shows the ninth, tenth, and eleventh trading days rising strongly as well. One possible explanation is that this mid-month bulge is caused by the enormous growth of 401(k) retirement plans (participants’ salaries are usually paid twice monthly).

DJIA gains more on first day than all other days

Over the last 15 1/4 years the Dow Jones Industrial Average has gained more points on the first trading days of all months than all other days combined. While the Dow has gained 5481.72 points between September 2, 1997 (7622.42) and December 31, 2012 (13104.14), 5323.19 points were gained on the first trading days of these 184 months. The remaining 3674 trading days combined gained just 158.53 points during the period. This averages out to gains of 28.93 points on first days, in contrast to only 0.04 points on all others. See Table 1.

Note that September 1997 through October 2000 racked up a total gain of 2632.39 Dow points on the first trading days of these 38 months (winners except for seven occasions). But between November 2000 and September 2002, when the 2000-2002 bear markets did the bulk of their damage, frightened investors switched from pouring money into the market on that day to pulling it out in fourteen months out of twenty-three. This netted a 404.80 Dow point loss. The 2007-2009 bear market lopped off 964.14 Dow points on first days in 17 months from November 2007 to March 2009. First days had their worst year in 2011, declining seven times for a total loss of 644.45 Dow points.

First days of June have performed worst. Triple digit declines in four of the last five years have resulted in the worst net loss. August is the second net loser. In rising market trends, first days perform much better as institutions are likely anticipating strong performance at each month’s outset. S&P 500 first days track the Dow’s pattern closely but NASDAQ first days are not as strong with weakness in April, August, and October.

Table 1: DJIA Points Gained First Day of Month September 1997 to December 2012

Aura of the witch: Heightened volatility surrounds quarterly expiration

Since the early days of the Stock Trader’s Almanac over 45 years ago, we observed that options expiration had a profound impact on the stock market and have been reminding investors of the expiration of stock options ever since. Initially, it was just a written notation on the annual strategy calendars. In 1977 we added a circle around the expiration dates so users could see them at a glance. In 1987 a skull and crossbones icon was placed in the weekly calendar pages on the third Friday of each month to alert folks to the increased volatility around options expiration.

Financial incantations

Traders have long sought to understand and master the magic of this quarterly phenomenon. On the third Friday of every month options expire but in March, June, September, and December a powerful coven gathers. Since the S&P index futures began trading in June 1982 stock options, index options as well as index futures all expire at the same time four times each year—known as Triple Witching.

The 1988 edition of the Almanac includes three skull and crossbones icons on the third Friday of March, June, September, and December, when stock index futures contracts expired; embracing the new term “Triple Witching” that had become popular on Wall Street. In 2001 the skull and crossbones was replaced with the witch icon currently in use. Just as the moon affects the tide, the expiration of options and futures contracts pulls the stock market into a cycle of volatility that drives cash into and out of the market, which drives the direction of stock prices.

The recent advent of single-stock futures has given rise to the term “quadruple witching,” but the market is still relatively small so the name has not fully caught on. Even the recent proliferation of weekly and other non standard option contracts has not been able to diminish the influence of equity index futures or dethrone the cycle of Triple Witching.

Increased volatility and trading volume across the equity exchanges is often associated with Triple Witching—the Friday of expiration and the days leading up to it. An examination of Triple Witching patterns and seasonalities casts a ray of light on these mystical conjurations, and may help you summon an edge and potentially increase profits while warding off losses.

For years we have analyzed what the market does prior, during, and following Triple Witching expirations in search of consistent trading patterns. This is never easy. As soon as a pattern becomes obvious, the market tends to anticipate it and the pattern tends to shift. Following are some of my findings of how the Dow Jones Industrials perform around Triple Witching time.

Market trance week after expiry

Triple Witching Weeks have become more bullish in the last decade. The weeks following Triple Witching Weeks have become more bearish, especially in the second quarter. The Dow has not had a positive week after June Triple-Witching Week since 1998. Triple Witching Weeks have tended to be down in flat periods and dramatically so during bear markets.

Down weeks tend to follow down Triple Witching Weeks. This is an interesting pattern. Since 1991, of 30 down Triple Witching Weeks, 22 following weeks were also down. This is surprising inasmuch as the previous decade had an exactly opposite pattern: there were 13 down Triple Witching Weeks then, but 12 up weeks followed them.

Seasons of the witch

By breaking down Triple Witching Weeks quarter by quarter, an even clearer pattern emerges. Table 2 shows that Triple Witching Weeks in the second and third quarter are much weaker and downright horrendous in the weeks following, but in the first and fourth quarter a solid bullish bias is evident.

It is not coincidental that these strong Triple Witching Weeks occur during the Best Six Months period November through April while trading around Triple Witching Weeks is rather dismal in the Worst Six months May through October.

As shown in Table 2, since 1991 second quarter Triple Witching Weeks have been up 13 times and down 9. Following weeks were atrocious, down 20 and up only 2 times. One up week followed the six up Triple Witching Weeks whereas 8 down weeks followed 9 down Triple Witching Weeks.

Third quarter Triple Witching Weeks were slightly better, up 13 of the last 22 times. But weeks following Triple Witching were down 17 of the last 22. Four up weeks followed the 13 up Triple Witching Weeks and 8 down weeks followed the 9 down Triple-Witching Weeks.

The tables turn dramatically in the first and fourth quarters. First quarter Triple Witching Weeks perform quite well, up 15 of the last 22, but weeks following have been down 13 times. Six up weeks followed the 15 up Triple Witching Weeks and 4 down weeks followed the 7 down Triple Witching Weeks.

Fourth quarter Triple Witching has proved to be the most favorable. Triple Witching Week was up 17 of the last 22 times and the following week was up 15 of 22 times. Twelve up weeks followed the 17 up Triple Witching Weeks and 2 down weeks followed the 5 down Triple Witching Weeks.

Table 2: Triple Witching Week & Week After Dow Point Changes

Manic Monday and Freaky Friday

Market performance on Mondays and Fridays is critical. How traders behave at the beginnings and ends of weeks can be indicative of the market’s future course. Therefore, market performance on the Monday before Triple Witching and on expiration Friday possesses even greater significance.

March Triple Witching Monday has been up 16 of the last 23 while Friday is up only 12 of those times. In June, Monday is up 12 of 23 and Friday has risen 14 times. In September, now the worst month of the year, Monday before Triple Witching is up 15 of the last 23 occurrences and Friday 13 times (8 straight 2004-2011). December, one of the year’s top months, has experienced the most bullishness at Triple Witching time in recent years. On Mondays of December Triple Witching the Dow has advanced 13 of the last 23 years and Fridays saw gains in 14 of those years.

This further underscores the trepidations traders and investors may face during the often-volatile month of March. Being positioned ahead of the normally bullish March Triple Witching week, while using strength that week to lock in some gains, may be the wisest course for those investing for shorter time frames. Short-term tops often occur during March Triple Witching Week.

Witches brew

Seasonal tendencies of the stock market during the cycle of expiration Friday and Triple Witching is difficult to ignore. A financial transaction event that occurs with such consistent regularity and involves the transfer of massive amounts of money by the largest financial institutions in the world has created a discernible cyclical pattern in the stock market.

I stay mindful of these quarterly affairs when making portfolio decisions and adjustments. For the most part, I find that I may be better served by adding long positions the week after Triple Witching and taking profits during Triple Witching week. And I always remember that both the week of and after Triple Witching can be especially volatile during June and September with a distinctly negative bias.

JEFFREY A. HIRSCH is editor-in-chief of the Stock Trader's Almanac and Almanac Investor newsletter, and the author of The Little Book of Stock Market Cycles (Wiley, 2012).

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Article copyright ©2013 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.
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