Welcome to a brand new month, Evolvers!
December is a special one for stocks.
Historically, it’s been one of the best-performing periods of the year for the S&P 500 ETF Trust (NYSEARCA: SPY).
Why? Usually, because of tax loss harvesting, trading volume, and trader sentiment heading into the new year (more on that later…)
And following the bullish reaction to Federal Reserve Chairman Jerome Powell’s speech at the Brookings Institute yesterday, it’s possible that the market is gearing up for yet another ‘Santa Claus rally.’
But anyone who’s been trading this unpredictable bear market knows that 2022 is very different from most years.
(On average, the SPY gains about 9% per year. In 2022, it’s down 15% YTD.)
So, it goes without saying that we can’t expect past history to predict price action in 2022.
With the SPY already up 16% off the October lows, it’s possible the year-end rally happened slightly earlier this year.
On the other hand, yesterday’s massive surge — with the SPY gaining more than 2.8% intraday — suggests otherwise.
Keep reading and we’ll try to answer the remaining questions about trading this December…
Will Newbies Trade More During the Holidays?
A major reason the market normally gets hot in December is that bored newbies enter the market.
Think about it…
When average Joes go home for the holidays, they get tired of drinking egg nog with their boring inlaws for days on end.
Soon enough, they find themselves dipping their toes in the market.
They trade for just a few weeks, flooding the market with newbies. And many of them have unrealistic expectations of getting rich immediately.
When this happens, experienced traders (like me) get to trade a red-hot holiday market … filled with inexperienced newbies to trade against!
But as I mentioned earlier, 2022 isn’t like most years in the stock market.
With stocks down so much, will newbies still be intrigued to play the ‘Santa Claus rally?’ Or will this year’s bearishness make them less interested?
To figure this out, let’s go over exactly what the Santa Claus rally is (and what usually causes it)…
Is Santa Claus Coming to Trade?
If you’re unfamiliar with the Santa Claus rally, it’s time to put down the milk and cookies and pay attention…
The Santa Claus rally is a legitimate phenomenon in the stock market. It occurs during the last five trading days of December and ends on the second trading day in January.
Since 1928, this seven-day period has returned an average of 1.7% in the S&P 500. Additionally, the S&P 500 has increased during this week 70 out of 90 years (78% of the time).
As a trader, you gotta love these odds. It’s rare that a single week in the S&P 500 has an 80% historical win rate.
But what’s actually going on with the Santa Claus rally? What specific factors cause this bullish sentiment to close out the year?
While no one knows exactly why the rally takes place, market historians have linked this incredible price action to three main factors:
- Heightened trader purchases ahead of the January effect (more on that in a future issue)…
- Lighter trading volume due to holiday travel (which makes it easier to move the market higher)…
- A decrease in tax-loss harvesting (which can weigh down prices at the beginning of December)…
Once again, this is why knowing your history is SO important.
If I wasn’t aware of the history of the Santa Claus rally, I’d probably be shorting stocks and buying puts during the final ramp of the year.
(Notice how poorly that strategy would’ve performed after yesterday’s huge SPY rally!)
Now that I know what usually happens in December, I respect the historical precedent and prefer to sit on the sidelines for the most part.
But again, 2022 isn’t a normal year, so I’ll also be watching for signs of a disruption to the Santa Claus rally.
Bottom line: Know your history, assess the current price action, then trade accordingly.
As you can see, December is usually a strong month for stocks.
Keep this in mind as you trade this month.
Consider the history, but never bank on a perfect repeat of past price action.
Take things day by day, pay attention to the trading volume, and stay nimble in case the market does something unexpected (which it often does)!