Turn-of-the-month opportunity

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Turn-of-the-month opportunityTurn-of-the-month opportunity

By Tim Fligg | December 15, 2014

One of the most basic time-based trades is buying the Dow Jones Industrial Average or SP 500 the last two days of the month and selling it on the first or second day of the new month. The trader who introduced this strategy to me called it the “turn-of-the-month trade.” The first four months it was used, it worked every time. It seemed like the best-kept trading secret.

Research followed. This was before 2000, and it was not as simple as it is today. Now, in the age of the Internet, this strategy is more widely known, and variations abound. Some say to buy 10 days before, five days before or three days before, and then sell on the fourth day of the new month. Despite its simplicity, the strategy can be confusing, especially to new traders.

After 15 years of trading at a professional level, the importance of breaking every trade down to a granular level has become self-evident. For long-term and repeatable success, it’s critical to know the exact moment to get in and get out. You want the highest probabilities with quantified data in your favor.

When Wei Xu and John J. McConnell from Purdue explored this concept in their 2006 paper “Equity returns at the turn of the month,” it sparked new interest in the strategy. Then, Victor Niederhoffer’s coverage of it in his book The Education of a Speculator . particularly with respect to the timing and the probability of the trade, drove home the importance of precision at the time of execution.

This trade makes sense because it corresponds to the timing of monthly cash flows received by pension funds, 401(k) contributions, stock purchase programs, IRA contributions and stock dividends—all of which get reinvested in the stock market.

Using Bloomberg API and Microsoft Excel, you can figure out the exact moment to get into a trade and when to get out based on historical data. In addition, you can identify the months in which you should employ this strategy and when you shouldn’t. A lot of traders use a blanket approach and always stick to the same trade and method. But if you examine the E-mini futures or SPY, you can identify certain months from January 2009 through June 2014 when this strategy works 100% of the time, whereas certain months there is a 17% chance of it working.

Also, while it may seem insignificant, the difference between your entry and exit strategy is monumental over the long term. Opening imbalances, closing imbalances or Volume-Weighted Average Price (VWAP) orders are important concepts. When someone sends an order in to buy pre-market, they get the opening price. When someone sends in a market-on-close order, they get the closing price. If someone says “buy 100,000 XYZ and VWAP it,” they’re going to have their order slowly bought or sold with the volume throughout the day, and at the end they’ll get the VWAP.

Running regression analysis on SPY alone, if you were to buy the open four days prior to the end of the month and sell it on the open on the fifth day of the new month, history suggests a 53.86% cumulative return over the study period. Whereas if you used a market-on-close order and bought the close five days prior to the new month and sold your position on the fifth day on the close, you might expect a 66.42% cumulative return, with an average move of 1.02%. The biggest move was 8.73% on November-December 2011, and the biggest loser was 10.27% on July-August 2011 (see “Best worst,” below).