Price Seasonality and why it Matters in Trading

Price Seasonality and why it Matters in Trading

As I have explained before, traders use technical and fundamental analysis to determine their entry and exit positions. Technical analysis uses historical data and a combination of technical indicators to forecast future performance. It is a very important technique that actually works when used properly. On the other hand, fundamental analysis involves the use of financial and economic news to make decisions. For instance, macro data such as inflation and interest rates play an important role in this. However, there is another strategy that is commonly used by long-term investors. It’s called seasonality.

This is a simple strategy that explains how markets move in accordance to various seasons. It is defined as a pattern that occurs at different times within a calendar year. In equities, the January effect is a very common phenomenon. The January effect was first identified in 1942 and was publicized in 1992 by Robert Haugen. Ideally, the January effect is based on the fact that stocks perform very well in the last trading day of December and the 5th trading day of January. This happens because of a number of reasons such as the reversal of year-end flows. As it is common with many investors, they usually rush to cash in their stocks to create tax losses and make their gains. In addition, at the beginning of the year, many investors convert their currencies to dollars when starting their ‘new year’ portfolios.

Another common seasonality concept is known as the Mark Twain effect which is based on a quote by Mark Twain. This concept refers to the stock prices in end October where they end lower. 50 years of data has shown that the probability of this happening are high.

In a report compiled by Kathy Lien, a prolific day trader and author, she found that between 1997 and 2007, the EURUSD pair has fallen (dollar strength) 9 times. The pair only rose in 2003 and 2006. This is shown in the chart below.

price_seasonality

In addition, this seasonality case is shown in the figure below by looking at the United States dollar and Swiss Franc.