Daryl Guppy

Beware of old dealing myths: Go away in May

By Daryl Guppy (China Daily)
Updated: 2010-05-10 10:45

The market has many snappy but out-of-date sayings that are a hangover from other centuries. These are regularly quoted and although many are now meaningless, some people have not learnt to ignore them. Some sayings are an accurate summary of market conditions and they can point the way to some opportunities.

At this time of the year we hear "Sell in May and stay away". It is market idiom and it sounds profound. The dramatic fall in the US market last week gives credence to the saying.

The original saying was "Sell in May and go away but come back on St Leger Day". May was the start of the English summer social season for the rich involving holidays, polo, cricket, trout fishing, croquet, racing, tennis, hunting and boating. The holiday season ended with the running of the St Leger Cup in early September.

This observation is based on the laziness of English stockbrokers, and their clients, who took holidays in this period during the 19th century. It was less relevant in the 20th century, but the saying persisted. Now, in the 21st century it still lingers as a quaint aphorism, unfortunately still believed by many. The hard statistical analysis shows following this advice is often a great way to hand your profits to somebody else.

Those who went away in May 2009 missed out profits as high as 30 percent by the end of September in some markets.

Looking over the past 20 years the English FTSE index rose 50 percent of the time between May and September. Sellers in May missed out on the dramatic 21 percent rise in 2009. The worst performing year, 2002, delivered a 28 percent loss. In the homeland of this saying it's a 50 percent each way bet.

The social structure of the United States is very different to the aristocratic social structure of England in the 19th century and yet the saying is used with the same vigor. It is more inappropriate. Following this advice over the past 20 years investors missed out on a rising Dow for 60 percent of the time. They missed the best return in 20 years of 15 percent for 2009. Those who do not use the strategy join a rising market in 60 percent of years. They did avoid a 23 percent decline in 2002 but this is no compensation for the profits foregone in other years.

Trying to apply this saying to more recently developed markets is not wise but it does not prevent people from trying. China market traders foolish enough to follow this advice missed good profits in 58 percent of the past 12 years. The best year for this advice was 2007 with a 41 percent return. The worst year was a loss of 38 percent in 2008 where selling in May made sense but the 58 percent probability of a rising period does not justify blindly following the advice.

The failure of this advice to sell in May does not mean that the opposite is true. The market rises more often than not, but it can be a bumpy ride. The market this year could just develop the conditions to make this saying come true. Investor protection comes from watching and managing the market trend rather than blindly following an old fashioned saying.

The market does include reliable seasonal behavior. Understanding the reliable behavior can provide a short term advantage in the markets. The tax year ends in April in the US and in June in Australia. Markets typically pause just prior to the end of the tax year as investors, fund managers and traders close their account books with tax-motivated selling. Selling before the lunar year ends is high probability behavior in the weeks prior to the spring festival so the market has a high probability of falling.

The Shanghai market also has a high 77 percent probability of rising in the month following the spring festival. It's a pattern derived from the repeated behavior of people. In Western markets the few weeks prior to Christmas often develop a Christmas rally that may continue into January. The impact of these behaviors is usually not large, and it is only index futures traders who can turn these events into a reasonable profit.

It is dangerous to rely on simplified myths in the market because markets have changed substantially in the last 20 years. They have also changed significantly in the last two years as a result of the global financial crisis. The validity of every myth should be verified against the reality of the market.

Markets change but it often takes a long time for the participants in the market to catch up. The advantage, and the profits, go to the traders and investors who refuse to accept common thinking.

The author is a well-known international financial technical analysis expert.