Tuesday, April 23, 2024
InvestingTrading

Turn Of The Month Trading Strategy (2023 Update)

The Turn Of The Month Trading Strategy is a well-documented strategy for trading indices such as the S&P 500 & FTSE 100. The idea is simply that the markets make greater than average positive moves from the last part of the month to the early part of the next month.

According to quantpedia.com Lakonishok and Smidt (1988) were the first to have reported a turn-of-the-month seasonality in equity returns.

Although many academics have tried to show as to why there would be an effect, giving reasons such as pay days and pension fund investment timings, it still seems unproved as to why it might happen.

Turn Of The Month Trading Strategy: Trading Days Method.

This is where researchers differ slightly in their proposals.

Lakonishok and Smidt  suggested this should be traded over the 4 day period saying, “Despite the simplicity of the trading strategy based on this anomaly (for example, to buy SPY ETF 1day before the end of the month and to sell it 3rd trading day of the new month at the close), the strategy is both profitable and statistically significant”. 

Other more common methods such as the one at quantifiedstrategies.com which states, “go long at the close on the fifth last trading day of the month, and we exit after seven days (at the close of the third trading day of the next month)”.

While there are differences, it seems that the main thing is to at least include the original dates set out by Lakonishok and Smidt  to buy SPY ETF 1 day before the end of the month and to sell it 3rd trading day of the new month.

Turn Of The Month Trading Strategy: Historical Performance

There has been a lot of research into this over the years. Here is a summary of a few of the findings.

The UK Stock Market Almanac references the paper ‘Dash for Cash: Monthly Market Impact of Institutional Liquidity Needs’ which is a free paper and goes into great depth.

In the Stock Market Almanac, they showed a graph that over a 14 year period from 2003 to 2017 the TOM strategy outperformed the Buy & Hold strategy significantly. Growing from 100 to a value of 349 as opposed to the 213 value of buying and holding the FTSE all share.

QuantifiedStrategies.com have done a long research piece and backtests on multiple markets. The S&P 500 since at least 1960 showed only a small advantage with CAGR (compound annual growth rate) of 7.2% compared to a buy and hold strategy of 7.1%. However the drawdown was about half. They found that strategy had worked better on different markets. Emerging markets and particularly the Brazilian market had returned CAGR of 19.7% compared to the buy and hold CAGR of 6.2%. Clearly worth doing. They even tested this strategy for Bitcoin which had CAGR of the buy and hold strategy of 94.2% since 2015. However the TOM CAGR was only 51.3%. I suppose you could call that a bitter sweet investment.

In previous research I had also looked at the years 2014 to mid 2016 on the same strategy on the S&P 500. The average return for this period was 0.29% per monthly trade with a total gain of 154 points, however the buy and hold strategy would have yielded a 330 point return.  

My research during this period also showed that if you excluded the turn of the month trade from December to January, then the outcome could be improved to hit 310 points. Nearly but not quite matching the buy and hold strategy.

Does the Turn of The Month Trading Strategy still work?

As a quick test I have looked back at 2022. T is the last trading day of the month.

The S&P 500 results table shown below shows an average monthly return of -0.40% and a total return of -4.82% . A loss! Obviously not great news. However, if we compare this to the returns of buying the S&P 500 on our first open date and holding for the period the returns would have been -11.42%.

Our results table shown below shows an average monthly return of 0.54% and a total return of 6.49% . Atleast we are positive this time. However, if we compare this to the returns of buying the FTSE 100 on our first open date and holding for the period the returns would have been 3.55%. So again this is a favourable strategy.

Conclusions on the Turn of The Month Trading Strategy.

The big problem it would seem with this strategy though is that the returns are so small, that any expenses incurred trading the positions could have a big impact and make the strategy no better than the buy and hold strategy.

We could argue however that even though the returns aren’t big, that does mean that you have that cash to trade with for the rest of the month. So for a trader with other strategies, this could definitely be something to consider.

The question now is can we improve on the Turn of The Month Trading Strategy? I touched upon this and found potential improvement by excluding the December trade. If you are into trading there are thousands of indicators that could be used to potentially improve it, such as relative strength or the use of moving averages.