Why traders need to be more selective during the summer months
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There is reasonable evidence to suggest that the six months between November and the end of April are the best time of year to trade stocks.
The November-April period historically outperforms the six-month period between May and October for stocks in many countries and time periods.
This event has been recorded throughout Countless countries and three centuries of the United Kingdom data. Sometimes, this is referred to as the ‘Halloween indicator’ or the ‘sell in May and go away’ rule.
In this blog post, we will look at why the stock market performs poorly during the summer months and why traders should be more selective during these months.
Why do stocks perform poorly in summer?
Summer months are often characterized by low volume and sometimes low volatility in the stock market. This is because most stock traders sell their stocks in May to come back after the summer.
Therefore, fewer traders are active in the market during the summer months.
According to research and data compiled by Bloomberg for international and US stock markets, the winter and spring months after traders return from their summer vacations have historically produced better yields than the rest of the year.
Historically, the key times are the end and beginning of the year when market players are optimistic and resilient.
According to the data, stocks return around 2% during the summer, compared to around 7% during the winter months. Although this is not always the case every year, the data is statistically significant and massive returns are recorded more than 60% during winter.
The research is based on the S&P 500 index, which tracks the 500 largest American companies. A similar pattern has been observed in market indices of other countries.
However, it is worth noting that this effect is relevant for exchange-traded funds (ETFs) and index funds, not individual stocks.
In summary, it appears that over the long run, the stock market has on average underperformed in the summer months and outperformed in the winter months.
That is why it is important for traders to be more selective during summer trading as the season is slower.
When trading during the summer months, you need to focus on what can help you avoid losses when the market is experiencing reduced liquidity and volatility.
Let’s take a look at few important rules that you should follow in your daily trading activity during summer.
- Focus on trading only one strategy: Focusing on a single strategy when trading stocks during the summer months means you won’t get distracted by trying to hunt for many different setups. Getting good at applying just one proven successful strategy can get you better results in the long run than trying to mix and match many of them.
- Do not trade more than one stock at a time: This is an important point to remember, especially when you are implementing a strategy where the average holding time is as short as a few seconds or a few minutes. The last thing you want to do is try to trade two or more stocks at once.
- Stop trading after 11:30 am: Momentum in the stock market is really hot during the first two hours after the opening bell. This applies more to small-cap and low-cost stocks that trade below $10. That’s why it’s a good idea not to make any trades after 11:30 am so that you can focus on reviewing your trades throughout the day.
- Make no more than 5 trades per day: Statistically, you are likely to lose more money when you make more than five trades per day. By following this simple rule, you can avoid repeating the pain of your worst days.
- Do not trade during pre-market session: The best time to prepare for a trading day is before the opening bell rings. Pre-market sessions usually have poor liquidity and this often leads to wide spreads and bad fills due to slippage.
Besides, the last thing you want to do is start your day when you’ve already lost some money after executing a trade during the pre-market session.
This can have an emotional impact on your ability to find the best opportunity when the normal trading session begins.
- Use only “A” quality setups: Once you observe the above rules, it will be easier to follow. Your bottom line mindset should always be this: You are not forced to enter a single trade every day. This approach can greatly help you filter out any setups that do not carry the high potential/small risk ratio required to enter a trade.
A catalyst refers to something that is moving the stock. Fortunately, catalysts do not respect the seasons and often occur during the summer months.
In addition to following the above rules, individuals trading during the summer months should also be on the lookout for stock catalysts. A stock catalyst refers to any event or news that increases or decreases the price and volume of a stock.
Here are some stock catalysts you should watch for a profitable summer trading season.
Popular catalysts to watch in the summer period
- Earnings of the company – Many public companies release their quarterly financial results during the summer. These earnings lead to significant market movements.
Generally, stock prices rise in response to earnings reports that beat expectations (and vice versa).
- Management changes – Stocks can also experience high volatility when a company announces a change in its board of directors or management. For example, if the departure of an underperforming CEO is announced, the stock may jump higher.
- Mergers and Acquisitions – Merger and acquisition deals are common in the stock market and can be announced at any time of the year. When such a deal is announced, it leads to volatility in the stock market.
- Social media – Social media can also drive the stock market. A good example is when retail traders flocked to Reddit and other social media sites in 2021, driving stocks like GameStop ( GME ) and AMC ( AMC ) to record highs.
As a trader, your job is to adapt to the ever-changing environment of volatility, liquidity and price action.
The stock market experiences lower volume and sometimes lower volatility during the summer months. However, this period is not an entirely terrible time to trade.
While liquidity and volatility are generally lower in the summer, plenty of opportunities arise that can help you make profitable trades.
When trading in the summer, you need to be more selective as it is slower and look for stock catalysts. More importantly, keep in mind that the principles of price action and technical analysis always apply.