The Halloween Effect: Trick or Treat? By, Ron William, CFTe

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Elevated market volatility and black swan event risk is already proving to scare most investors as we approach the ominous Halloween festivity. It is claimed to be influenced by Germanic and Celtic-speaking peoples commemorating the dead at the beginning of winter. Meanwhile, in financial markets, Halloween’s (late October) timing coincides with the aftermath of an infamous fall-crash pattern (Figure 1), which typically fuels a relief rally from oversold extremes.1124 RW Chart1 1

Halloween’s original philosophy of “commemorating the dead” also serves as a useful metaphor of the investor behavioural realities for mourning and overcoming portfolio loss, not least during the market carnage of 2022. Typically, the worst drawdown occurs in September, as it did this year, marked by a false low, which is then followed by a true low in October. Therefore, October is often remembered as the anniversary month of significant falls or crashes, notably 1987.

In terms of seasonality patterns, the drawdown impact often triggers a so-called “Halloween Effect” (HE), akin to the mythological phoenix rising from the ashes. Intra-month analysis shows the worst of the drawdown on average is between October 22nd and 27th, setting up the HE into the month’s end (Figure 2).

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The upside reversal often signals a temporary or complete end to the bear market (Figure 3), thereby leading to the “Best Six Months” (BSM) of market performance.

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Peer-reviewed papers show how well this seasonal pattern has worked for centuries, by a statistically significant amount (Figure 4); with November-April (BSM) outperforming May-October, known as the “Worst Six Months” (WSM), or “Sell in May and Go Away”.

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The big question now is: Will this coming HE trick-or-treat investors?

Further support is offered by the pending US mid-terms which historically triggers one of the most bullish phases of the four-year election cycle, according to Ned Davis Research (NDR) (Figure 5).

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But with the macro backdrop seemingly terrible, which will win? The presidential cycle is more than markets randomly shifting trends after midterms. It’s the combination of monetary and fiscal policy that typically bottoms before midterms and accelerates through the pre-election year. The NDR index of both policy factors is near a record low and may serve as a contrarian bullish setup. Perhaps a Fed or Fiscal pivot is finally ahead. Or, perhaps an unknown scenario we have yet to discover?

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A glance at the S&P500 chart already shows an impulsive relief rally from oversold conditions (Figure 6). Recall that a bear market rally often explodes by an average of 23%. This implies a minimum price objective into a 200-day trend average currently trading near 4100, with overshoot risk into 4385 (a 66% retrace level). Probability, not a certainty. This Halloween, the light-hearted guidance is to craft your pumpkins, not pump your trades too early. Be prudent and Happy Halloween! 🙂

Thank you to all VTI members for all your kind feedback and insightful questions on my new Blog market & mind series! I welcome more interaction via social media or on [email protected]  and watch out for our VTI e-learning courses on the triad approach of Macro, Fundamental and Technical Analysis!

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