Academics have shown that changes in our mood can directly affect our behaviour patterns, including how we make investment decisions (Paper 'Winter Blues: A SAD Stock Market Cycle', Mark Kamstra, Lisa Kramer and Levi, Federal Reserve Bank of Atlanta, October 2003). As I proved in the summer of 2010 with my highly profitable short index trade on the S&P 500 at the start of the FIFA Football World Cup, the US equity market has a nasty habit of falling during the month-long tournament ('A World Cup Winner', 14 May 2010), we can take advantage of the mood changes of investors, and their impact on the performance of the stock market, if we know when this is likely to occur.
St Patrick's Day
In a study, 'Testing for Non-Secular Regularities in Stock Returns and Trading Activity', academics Laura Frieder and Avanidhar Subrahmanyam looked at the performance of the US stock market between 1946 and 2000 around the time of St Patrick's Day. This Catholic holy day was first celebrated more than 300 years ago, and has since become a festive occasion, with the Irish community celebrating the day, which falls on 17 March each year, by drinking and parading. This positive behaviour seems to spill over to investors, with the US stock market rising on average by 0.34 per cent two trading days prior to St Patrick's Day, by 0.37 per cent the day before, by 0.07 per cent on the day itself and by 0.19 per cent on the day after. Cumulatively, that is a return of 0.97 per cent over the four-day period.
And the trend for prices to rise around St Patrick's Day still seems to be working: the S&P 500 rose by 0.6 per cent over the four-day trading period in March 2006, 1.6 per cent in 2007, 1.7 per cent in 2008, a hefty 5.8 per cent in March 2009 and 1.4 per cent in 2010. And even last year when markets were incredibly volatile in March in the aftermath of the Tokyo earthquake, and the trade would have been closed out for a small loss the day after St Patrick's Day, investors who held their nerve for a day longer would have made a profit.
Reasons for this phenomenon
Part of these healthy gains could result from the fact that March is a good time of the year to be invested in equities. But the average return on the four trading days around St Patrick's Day accounts for almost all the 1 per cent return the S&P 500 index has averaged over the month of March in the past six decades. That's astonishing, so perhaps there is another factor at play here?
Another reason for the market to rise in this four-day trading period is the crossover with 'triple witching week', when stock options, index options and index futures all expire on Wall Street. This can give the S&P 500 a boost as traders settling these options and index contracts may be forced to buy into the market to close their positions.
The market has risen far more often than it has fallen during triple witching week over the past two decades. And as triple witching day in the first quarter falls on the third Friday of March (Friday 16 March this year) there is more often than not some crossover with St Patrick's Day.
Trading strategy: St Patrick's Day
The standout trading strategy is to buy an S&P 500 index tracker two days before St Patrick's Day and look to take profits at the close of trading the day after the festival to try to capture the near-1 per cent average rise in the index over this four-day period. Exchange-traded funds (ETFs) listed on the London Stock Exchange that track the performance of the S&P 500 index include iShares (TIDM: IUSA). The index can also be bought through a spread bet and, since you are betting in sterling for every point movement in the S&P 500, there is no currency risk, either. Profits from spread betting are tax-free in the UK and you can place a bet from as little as £1 per point on movements in the index. Spread-betting providers in the UK include City Index, IG Index, Capital Spreads, CMC Markets and Cantor Index.
You can also try to profit from this trading strategy using structured products as providers such as Societe Generale and Royal Bank of Scotland offer a range of covered warrants on the S&P 500.
Playing this trade through covered warrants is my preferred option and, in particular, I like Royal Bank of Scotland's covered call warrant RJ45, which has an exercise price of 1200, expiry of 15 June 2012 and a parity of 100:1. With the index trading at 1349, the warrants are priced on a tight bid-offer spread of 110p to 110.5p, which means that 86 per cent of the warrant price is 'in the money' and the balance is 'out of the money'. The effective gearing of the RJ45 call warrants is around six times the movement in the S&P 500.
If you'd prefer higher gearing for this trade then Societe Generale's covered call warrant S023 has an exercise price of 1350, expiry of 16 June 2012 and a parity of 100:1. This warrant is more sensitive to movements in the index as all of the warrant price – bid-offer spread of 40.6p to 40.9p – is time value. The effective gearing is around 10.5 times the movement in the S&P 500.
St Patrick's Day falls on Saturday 17 March this year, so my recommended trading strategy is to buy the S&P 500 at the close of trading on Wednesday 14 March and then close out the position on Tuesday 20 March.
Budgeting for profit
If you have banked gains on the S&P 500 trade, then you may be tempted to invest some of the proceeds on another trade the following week, when the Chancellor of the Exchequer delivers his annual March Budget. Politics may be a minefield but, thankfully, the stock markets are far more predictable in the way they react to Budgets. That's because share prices generally react favourably on Budget day, rising an incredible 75 per cent of the time in the past 68 Budgets since the Second World War. Indeed, the UK stock market has notched up gains on Budget day in each of the past six years, rising by 0.3 per cent in 2006, 0.7 per cent in 2007 and 1.6 per cent in March 2008. The Budget was delayed until 22 April in 2009, but the end result was the same, with the FTSE 100 rising by 1.1 per cent on the day. And this trend was maintained with the FTSE 100 posting a modest four-point rise on 24 March 2010 and 0.6 per cent on 23 March 2011.
The tendency for the market to rise on Budget day is actually very rational. It can be seen either as a relief rally by financial markets that there are no fiscal skeletons in the government's cupboard, or alternatively if the news is good for companies, taxpayers and the economy, investors will react favourably by marking up share prices. In effect, by buying shares just ahead of Budget day you are betting that there will be no nasty surprises in the chancellor’s speech that could unsettle the financial markets - and as our history books show this is a rare occurrence indeed.
Pre-Budget trading signals
Fortunately, we can increase the odds of making a profit on Budget day by looking at how prices move in the five trading days prior to the Budget. Stock market historian David Schwartz notes that share price movements in the range minus 0.7 per cent to plus 0.9 per cent in this five-day trading period is a great predictor that the stock market will rise on Budget day.
In fact, since 1944 there have been 27 occasions when the UK market moved in this range ahead of the Budget. It went on to rise on Budget day in no fewer than 24 of those years. The two near misses were tiny losses in 1995 and 2001. The market rose in this five-day trading range in 2006 and last year, and in both instances buying the FTSE 100 on the eve of the Budget would have been rewarded with some modest share price upside on Budget day.
Reasons why this happens
The fact that investors react so positively to the Budget when share prices move in this five-day trading range is easy to explain. Bullish, but not overly extended, share price rises ahead of Budget day indicate investor optimism and this positive momentum can easily carry through to Budget day. Equally, if share prices have marked time or made modest losses ahead of the Budget – indicating nervousness by investors – then, assuming there are no unpleasant surprises on the day itself, they are likely to greet the Budget positively as this risk aversion is likely to have been overdone.
Trading strategy: pre-Budget trade
This year's Budget is on Wednesday 21 March so it is worth monitoring movements in the FTSE 100 in the prior five-day trading period. If the change in the index is in the range minus 0.7 per cent to plus 0.9 per cent using the closing prices on Tuesday 13 March and Tuesday 20 March, then this is a great predictor that the stock market will rise on Budget day this year. It is also the signal to buy the FTSE 100 through either an ETF, spread bet, covered call warrant or listed turbo at the close of trading on Tuesday 20 March.
ETFs listed on the London Stock Exchange that track the performance of the FTSE 100 include those issued by Lyxor (TIDM: L100), a subsidiary of French investment bank Societe Generale, Deutsche Bank (TIDM: XUKX) and iShares (TIDM: ISF).
Alternatively, you can leverage up your capital through a spread bet or by buying covered call warrants. The FTSE 100 call warrant that appeals most for tightness of the bid-offer spread and its ability to operate as a geared tracker is Societe Generale's SY31, which has a mid-June expiry date, 5600 exercise price, 1,000:1 parity and is priced on a tight bid-offer spread of 33.8p to 34p, with the index trading at 5780. This means that 53 per cent of the warrant price is currently 'in the money' and the balance represents time value. The effective gearing of SY31 is around 10 times the movement of the FTSE 100 so, if the index rises by 1 per cent on Budget Day, you would expect SY31 to rise by about 10 per cent, assuming the index is still trading around 5780 and equity market volatility doesn't change significantly. No matter which way you play the trade, I would keep your position open on the FTSE 100 and keep a close eye on how the market behaves on the day after the Budget.
Post budget: trading rules
We can also make money in the weeks following the Budget just by following a few hard and fast rules.
Mr Schwartz points out that when share prices move markedly in one direction or another (outside the range of minus 0.5 per cent to plus 0.9 per cent) on Budget day and the following day, this is a great signal that the market will be higher 14 trading days later. For example, the UK stock market surged ahead by 1.1 per cent on these two days in March 2007, giving a major buy signal to investors. The index then rose by 1.7 per cent over the next 14 trading days, boosting the coffers of investors privy to these little-known trading patterns. In 2010 the market rose by 0.95 per cent over these two days and subsequently rose by a further 1.83 per cent to peak out on 15 April 2010. And last year the market surged 2 per cent over Budget day and the day after and then rose a further 2.2 per cent over the subsequent 14 trading days.
These are not one-offs; there have been 24 years since 1970 when the UK market has either risen more than 0.9 per cent or fallen by more than 0.5 per cent on Budget day and the day after. Surprisingly, 90 per cent of the time the FTSE All-Share was higher 14 trading days later.
Reasons why this happens
It is easy to explain why share prices behave in this way. First of all, a favourable reaction to the Budget is likely to mean that sentiment will remain positive in the weeks after the Budget, and increases the odds that share prices will rise in the subsequent 14-day trading period. Alternatively, if share prices have fallen too much following the Budget, it is quite possible that investors have been too harsh in their initial reaction. There is then scope for the market to bounce back as it has done regularly in the past four decades.
Trading strategy: post-Budget trade
If the UK market rises by more than 0.9 per cent or falls by more than 0.5 per cent on Budget Day and the day after - the dates are Wednesday 21 March and Thursday 22 March this year - and if you bought the FTSE 100 ahead of the Budget, then keep your position open for a further 14 trading days. If the index trades outside this specific range on these two days, then I would close the position.
If you don't have a trade open, then price movements of this order on Budget Day and the day after are a great signal to buy the FTSE 100 and try to profit from potential upside during the next 14 trading days up to Friday 13 April. Remember, in the past four decades when prices have traded in this range over these two days, the stock market was higher 14 trading days later an incredible 90 per cent of the time.
The proviso this year is that the clocks go forward one hour on Sunday 25 March and this has historically had a negative impact on the market the following day. Therefore, if the post-Budget signal has been given on Wednesday 21 March and Thursday 22 March, then I would look to buy into any weakness on the FTSE 100 on Monday 26 March as the ideal entry point for new positions and run the trade until Friday 13 April.
Daylight robbery
It may seem far-fetched, but it really is possible to make money from stock markets around the time of daylight changes. The reason for this is simple: we react to changes in our body clocks, or as the medical profession likes to call it: desynchronise. For example, as anyone who has suffered a bad night's sleep knows all too well, our behaviour the next day can be dogged by weariness, lethargy and in some cases despondency. The lack of one hour's sleep when the clocks go forward in the spring is hardly a major sleep imbalance. However, academics have shown that even minor sleep imbalances can cause errors in judgement, anxiety, impatience and loss of attention.
Insurance companies and car drivers know this to their cost: research confirms that there is a significant increase in car accidents following daylight-saving clock shifts in the spring and when clocks go back in the autumn. In a paper ‘Losing Sleep in The Market: The Daylight Saving Anomaly', academics Mark Kamstra, Lisa Kramer and Maurice Levi (source: American Financial Review, September 2000) found that stock market returns on the first business day of the week following daylight-saving weekends in the spring produced larger falls in the market than other weekends in the year.
In fact, taking data over a 30-year period from 1967 to 1998, the academics found that the mean negative return on the first trading day following spring daylight-saving weekends is between two and five times greater than that following an ordinary weekend. This is not just a local phenomenon, either, as the sample included the Nasdaq Composite, S&P 500 and New York Stock Exchange Composite, Tokyo Stock Exchange 300, Dax 30 and FTSE All-Share. The FTSE 100 index accounts for 85 per cent of the weighting of the FTSE All-Share and is therefore a proxy for the latter.
This trend has certainly held up in recent years, with the UK stock market falling nine times in the past 15 years on the Monday after clocks go forward in March. And there have been some sharp moves, too. For example, in 2009 the FTSE 100 took an absolute pounding on Monday 30 March, handsomely rewarding traders who took our advice and short-sold the index in advance with a 3.5 per cent unleveraged gain.
But even when the index doesn't eventually end down on the Monday after clocks go forward, there are ample opportunities to make a tidy profit during trading hours. In 2008, for example, when the FTSE 100 closed up 10 points on Monday 31 March, the index was still down 100 points at the open, giving nimble traders who short-sold the market at the close the previous Friday the opportunity to bank a healthy gain. A couple of years ago, when the index posted a seven-point gain on Monday 29 March 2010, traders who short-sold the index at 5703 on Friday 26 March ahead of the clock changes had the opportunity of banking an 18-point profit on the Monday. And, despite the strong performance of the market last year post the March Budget, the Monday after the daylight changes proved a damp squib for investors, with the index rising less than four points.
Trading strategy: daylight changes
The clocks go forward on Sunday 25 March this year, so if the post-Budget signal has not been given this year and we are not long of the FTSE 100 going into the daylight change weekend, then I would advise short-selling the index at close of play on Friday 23 March and look to bank a profit on Monday 26 March. Since 1981, the UK stock market has fallen 18 times on the last Monday of March, with an average decline of 0.93 per cent, and has only risen 13 times, with no fewer than nine of those rises being less than 1 per cent. Instruments to play this trade include ETFs, spread bets, covered put warrants and listed turbos.
Short ETFs that enable you to profit from falls in the FTSE 100 include Deutsche Bank db-x daily index tracker (TIDM: XUKS). Or, if you want to gear up movements in the index, then my preferred covered put warrant for this trade is Societe Generale's SN30, which has an exercise price of 6000, expiry in mid-June and parity of 1,000:1. So, with the index trading at 5780, SN30 is priced at 39.1p to 39.3p, which means the put warrant is geared 10 times to movements in the index with 56 per cent of the warrant price 'in the money' and the balance time value.
