It comes around once every year and it lasts for seven days. For decades, savvy traders have been listening with excited anticipation for reindeer bells, but what is this holiday phenomenon? What causes it, how can you trade it, and will history repeat itself in 2021?
A Santa Claus rally is best described as a significant increase in the stock market during the last week of December, continuing into the new year. It seems, Santa has little interest in other asset classes and focuses his holiday spirit on stocks, but what causes Wall Street to get that jolly feeling?
Here are the top three theories:
In many developed countries, employees receive a holiday bonus, and while some will use it to fill their Christmas stockings, others invest in their future, transferring earnings by buying shares in their own company or top-performing stocks.
While this theory is widely accepted, it doesn’t fully fit with market behavior. The rally tends to fizzle on January 2, which would suggest that all the bonus investors make their financial choices over Christmas. But not all EOY bonuses are received in that time, and why the abrupt cut-off on January 2? Moreover, why only stocks? Currencies, gold, or oil don’t experience the same rise. naughty list?
This theory speaks of a group of elite, well-funded investors who push and pull on the markets all year round. The theory suggests that these investors have better things to do during the holiday season, and they take a break from influencing global economies.
Those big investors are not always doing their own market analysis, there are firms that do the technical legwork for them and make investment recommendations. Over this period, those analysts are taking a hard-earned rest. Such a scenario fits the market behavior, but it’s not the only theory with credence.
Market sentiment refers to the feelings or expectations of the people who follow the markets more closely and react. Traders who analyze the markets every day will sharpen their instincts and even have insights beyond the standard signals and fundamental news.
Notable is that such instincts are considered emotional trading choices, which are not recommended, but mass sentiment has a real and measurable effect on the markets.
If events and media portray a positive light on a particular instrument, traders expect a rise and consequently Buy. If the media is widespread enough, a massive accumulation of buy orders cause the predicted rise to come true. Sentiment works like a self-fulfilling prophecy.
Wondering how often the prophecy comes true? The Santa Claus rally has occurred 34 times over the past 45 holiday seasons. So basically, we’ve see bullish stocks 3 holidays out of 4. So should you trade stocks this December?
Volatility can occur over the holiday season, which can make for a very profitable end of year, but if your leverage is set high, you may also be crying on Christmas morning. Not even Santa can offer guarantees, and as we say in the financial industry, past performance does not guarantee future results.
Keep your finger on the market pulse and stick to your tried and tested technical analysis. If your findings support a coming rally, then stocks may well be in your stockings this Christmas.