Breakout

Time to Buy? Let History Be Your Guide

Jeff Macke
Breakout

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Centuries of natural selection have hardwired human beings to find patterns and imagine relationships. This wiring is the basis of such things as lucky charms, special pre-game meals, ominous black cats and the idea that rising global temperatures are caused by, rather than correlated with, industrialization.

Given our superstitious nature, it could be tempting to dismiss the work of the Stock Trader's Almanac. Now in its 45th year, the Almanac culls market data from over a half-century to uncover seasonal trends and behaviors, outlining patterns that can improve a trader's odds of success. Scoff though you may, the Almanac is a mainstay of trading desks around the world and has uncovered such now conventional wisdom as Sell in May, the Santa Claus Rally, the January effect, and more.

The money question for 2011 is whether this year's horrific news flow will trump the trends, obviating any historical seasonal influences. Despite a U.S. credit rating downgrade in August, or the European crisis that reemerged as a headline story in September, Jeff Hirsch, who replaced his father Yale as the editor of the almanac says "no." He points to stocks suffering through a terrible September and bottoming in October, two events the Almanac accurately foretold. "Historical trends have held true," says Hirsch.

If seasonal patterns stay in place, November marks the beginning of stocks' strongest three-month period. With last month having been the 4th best October on record, history suggests even stronger gains than the norm. Of the 20 strongest Octobers since 1950, the period from November 1st to January 31st has been positive 17 times, with average gains over 6%.

Hirsch is looking for the trend to continue, regardless of the headlines. "The Europe crisis, though scary and serious, is noise," he says. "The market seems to be calloused and has baked it in at this point."

The pattern isn't perfect of course, nothing is. Scary and serious news that's not already baked into the market can trump historical patterns, Hirsch says, citing rising tensions in Iran specifically.

Regardless of the ever present risk of outside shocks, Hirsch is positioning for a rally by going long stocks. He's looking at dips towards the support levels as chances to add to his positions. He uses the Dow Jones Industrial Average to set his levels at 11,500 to 11,700. Given the atypically defined trading range of last summer, support is relatively easy to find no matter what index you choose. Simply find the top of the summer range, draw a line across the stock tops and, viola', you've found support.

Call it voodoo if you like. The fact of incremental moves in the market is this: If enough traders believe something to be true, and act on it, the prophecy becomes self-fulfilling.

As I said, the Stock Trader's Almanac is on the desk of traders all over the world. You can dismiss things like support levels and October bottoms all you want, but if you bet against them you've had some tough years. Or decades, as the case may be.

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