Trading the Holiday Effect

The Holiday effect is a well-known market phenomenon where a liquidity vacuum creates the possibility for large movements in price.  Also, there is a tendency for a strong price move into a holiday to continue but equally reverse easily when participation normalises.  Trading volatility can also be greatly exaggerated during these times and some research has shown that returns can be many times that during normal days*.

As desks close early, traders are absent, trades are closed to limit risk into holidays, and investors are generally in a boisterous mood around holidays, full of optimism about future prospects, and want to express this as a trading position, human behaviour plays a significant role in the change in the market environment.

Let us look into some of these features.

Here are some Characteristics of  the Holiday Effect

  • The data docket may be light or non-existent, and data may be delayed over the holidays.
  • Strong moves into the holidays tend to carry over into the holiday.
  • Larger participants tend to be less active.
  • Buyers and sellers pursuing fills struggle to locate the liquidity they need to efficiently execute orders.
  • Lower trading volume means the market will generally trade at a slower pace.
  • The liquidity vacuum also means the price can freely move away from the value before quickly reverting once participation is restored.
  • New important information that needs to be repriced can create extreme volatility.
  • Markets are busier/normal in the EU and Asia sessions and volume will die down past lunchtime.

Not all  Holidays are Created Equal

Christmas holidays coincide with year-end when many large institutions are rolling over and taking off positions to bank end of year holiday bonuses. This period generates one of the strongest effects but may be tied in with other more important actors. Everyone has heard of the Santa Claus rally where equities rally into the end of the year. 

Here is a back-test, where the S&P 500  is purchased the first day after 20th December and held until the first trading day of the year.

Santa Claus

Win Ratio 67%  with an average gain of 1%, Profit  Factor 4.8%  and Max Drawdown of 2.9% 

Returns on buy and hold over Christmas

Memorial Day

This is the equity curve for trading Memorial Day and the US holidays at the end of May.  We test the idea of buying into the holiday only to exit on the first trading day of June.

The results are poor and the effect is non-existent. The Average gain is only 0.18%  and the profit factor is 1.17  and Max Drawdown is 5%.

Returns on buy and hold over Memorial day

Other Seasonality Effects on Holiday Trading

Generally, there is a notion is that equities perform less well during some months of the year and outperform during the first and last quarters.   The holiday effect seems to tie in with this idea where the Santa  Claus and  Thanksgiving holiday returns are greater than average.   These two holidays coincide with the strongest quarter of the year where real-time updates from retailers on their holiday sales can affect individual names.  These updates are closely watched by markets for signs of consumer strength a significant driver of US economic strength into the last quarter.  Whereas weaker returns of other holidays coincide with weaker monthly returns mainly caused by seasonal effects. 

Dows average monthly returns

So it’s not as simple as it looks, No!

It would not be prudent to long every holiday with the exception of holidays falling in February, May, June and September but there is maybe something to watch out for.  Here are some top tips for traders wanting to trade over this period.  It is possible the effect is only an amplification of monthly and seasonal effects due to lower liquidity.  Post-holiday reversals are also real events and occur quite often, as with any weak auction that takes place it is susceptible to correction.  Signs of continuation should be closely monitored once full market participation is present.

KEY TAKEAWAYS:

  • Large participants may be absent during these periods, given that liquidity is limited moves may be exaggerated.  Momentum traders may find these conditions favourable with tight risk.
  • Maintain your trading discipline, HTF levels should be respected as larger participants skip the session.  In smaller Time frames participants tend to look for obvious anchors and prior reference points. This is actually a sign of weakness and weaker reference points have a habit of being revisited and broken.  If key reference points are not being respected this should be a major alert.
  • Be mindful of poor structure created as price and value separate in thin liquidity.   Look to trade value and not price, especially once participants return.
  • Stops can cause a cascade of other automated stops to create a sudden crash so be careful when trading near key areas where stops may be lurking.
  • Do not chase trades let them come to you. This is an important rule of trading and is never more important on days when liquidity is thin.
  • Be alert to new information, this can create a very volatile trading environment.
  • Watch other markets where participation is more regular for clues.
  • Step away and enjoy the holiday.

In a follow up to this blog I would like to continue to write about market seasonality and its effects on price movements.  I will explain how I use Python and prophet to analyse these effects and use the information to enhance my understanding and conviction.  If you found this piece interesting or would like to know more please message me to continue our chat.  You can find me at thebalancedtrader.com.

You can even follow me trading live on YouTube

Until then Trade Well and Prosper,   BT.

A few examples of holiday markets in action.

Memorial Day May 2022

market Profile

Candlesticks

First  Full Trading Day 2021

market profile