By Josip Causic, Online Trading Academy Options Instructor
The goal of this article is to find the so-called Santa Clause rally by examining the price pattern that forms at the end of each calendar year. In order to make a worthwhile conclusion, a specific time frame and underlying has to be selected and then they need to be back-tested for a bare minimum of six calendar years. Although six might not look like a lot of data, one could observe that certain patterns emerge even with only six pieces of data. In the following study, I include not only my observation of the QQQQ price action during the weeks leading to Christmas and New Year's (specifically the 4 weeks of December), but I also scrutinize the volume. The rationale behind selecting the QQQQ is very simple: It is an ETF (exchange traded fund) that tracks NASDAQ.
The figure below displays the QQQQ between the following dates: The end of November 2007 until the beginning of January 2009. Each candle on the chart is a weekly candle.
Figure 1 Observe the three purple rectangles, each one capturing the price action during December. For simplicity's sake, let us look at the chart from right to left for a change. The first rectangle captures the weekly price action between 11-28-2008 to 01-02-2009. Notice that TradeStation uses Friday as the demarcation for each weekly candle.
Notice that during that time, the price range was very small and the direction was mostly sideways. Specifically, two out of the four December candles were doji which represent complete indecision. After observing the price action on the chart, look at the lower study that shows the volume performance during the same time period; it is obvious that the volume was declining.
Next let us move from "last Christmas" to the one prior, and keep in mind the fact that the price at the end of 2008 was in a tight sideways range with declining volume. In the middle part of the chart for December 2007, I have used the same type of markings to show the similar behavior of the QQQQ. The volume was declining while out of four candles the first one green, the second was red, the third green, and the one just before the New 2008 Year was a doji. In other words, the QQQQ did not go anywhere.
The final and third observation is marked on the left side of the chart, starting at the end of November 2006 and ending with 01-05-2007. Observe, once again, that there was sideways movement with low volume and the candle colors were alternating between green and red in a tight range. After 2006 ended, the price action moved out of the range just slightly.
| |
2006 |
2007 |
2008 |
| Direction |
Sideways |
Sideways |
Sideways |
| Volume |
Declining |
Declining |
Declining |
Figure 2
The figure above captures the essence of the first three years in our back-testing. No Santa Claus rally in the last three years. As I mentioned earlier, a trader should avoid the tendency of jumping to a conclusion too early on a pool of data that isn't sufficient enough. In order to forecast more accurately, a trader ought to look at a bare minimum of six years of data, and then proceed with caution when making a conclusion. As always there are no absolutes in trading; we are always dealing with probabilities.
This next chart still shows weekly candles yet for the sake of demarcation of the exact dates, I have removed the lower studies which show the volume. As in the other years, the volume was low and declining going into the holiday season just before the New Year. This point has been made on Figure 1. On this chart, I have another observation to make.
Figure 3 Unlike the previous chart when there was not much of a change, observe that during December, every single candle was bearish. Hence, one could not make the statement that the market CANNOT fall apart before the end of the year. It is true that the market has not fallen apart for the last three years (2006, 2007, & 2008) yet here is proof that in 2005, it did go down. However, observe that whatever those four bearish candles had lost was all gained back in the first week of trading in 2006.
In the December 2004 price action, the middle rectangle shows a similarity to 2006, 2007, & 2008, in the sense that the range is sideways. Then, observe that the market moved down right after that in the first week of 2005.
The final and sixth analysis, the rectangle on the left, was done on the weeks between 11-28-2003 to 01-02-2004 and the price action was mildly bullish. The four December candles were red, green, red and green then after the end of 2003, the market took off for a couple weeks.
| |
2003 |
2004 |
2005 |
| Direction |
Mildly bullish |
Sideways |
Bearish |
| After the new year |
Briefly Rallied upward |
Tanked |
Briefly Rallied upward |
Figure 4
The above figure makes a quick summary of the second chart in order to bring home a point that no assumption should be made that the market always rallies during the weeks prior to Christmas and New Year. These six years of data were enough to point out that the market frequently goes sideways, and occasionally down. Many people talk about the Santa Clause rally, yet after completing an analysis of the last six years, the data shows that out of six years, only in one of those six was the market just slightly bullish. Due to this fact, I sell OTM bear call spreads on the weeklies the week before Christmas.
In conclusion, the Santa Clause rally is just as elusive as Santa Clause himself. Do not fall for what the CNBC propaganda is selling. Let the chart speak the truth. Be aware that after the New Year, the volume returns and the market could at that point do anything. Until then have green trading.
- Josip Causic
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