How to trade the Santa Claus Rally

December is a difficult month to trade as the year comes to an end and the holiday season sparks strange patterns in business and consumer spending. Most years in the lead up to Christmas and the start of January stock markets rally. But why does this happen and how can you take advantage of this?

The next few weeks will be deadly quiet in terms of trading as workers take holidays and less economic and earnings reports are released. On top of that, the stock and bond markets will close early on Christmas eve and Christmas day reducing the time you even can trade!

What is the Santa Claus Rally?

The Santa Claus Rally describes the increase in stock market prices that occurs at the end of December and beginning of January. There are many theories as to why this happens including: holiday bonuses, tax considerations, improved mood, and breaks from institutional investors. All things considered this increases consumer spending and drives up the prices of stocks with the added benefit of institutional investors taking leave to celebrate the holiday opening up investment opportunities for retail investors. 

Another reason that may drive up stock prices over this period is the anticipation of the January effect, where stock prices typically rise during January. More details on the January effect will come soon…

The Santa Claus Rally is a phenomenon that happens most but not all years. More than two-thirds of festive periods since the 1960s have seen a bullish market. The last five trading days of December and the first two trading days in January are typically when you can see the greatest rally with an average return found at 1.4% – which is fantastic news for those who are still actively trading over the holiday period.

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How should you trade the Santa Claus Rally?

To profit from cyclical trends such as the Santa Claus rally you can look into historical data to identify patterns. However, as some price movement is predictable from analysing these patterns the amount of risk and reward tends to reduce. You should bear this in mind when deciding on where to place your stop losses to ensure your expectations are realistic. 

You also must have the know-how to trade well on short time frames as this rally is over in a couple weeks. Trade to your strengths, remember, you shouldnt deviate from your trading plan because of an event like this, instead you should judge how you can include the Santa Claus Rally into your usual trading habits to reap the benefits. 

What shall I invest in?

Considering the current news of the generous US stimulus going through it’d be best to focus on US stocks over the next few weeks! 

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The most obvious and lucrative sector that does well over the holiday period is retailers. This year, considering the coronavirus pandemic and associated restrictions, focus on investing in online shops and megastores. For the US this could include Walmart, Target, TJX and Best Buy as these companies have proved they can stay in profits despite the difficulties going on. 

Some non-retail stocks that should also be successful are UPS and Starbucks for their own roles during the holiday season. Holiday themed drinks and ordering and sending gifts to loved ones is one thing corona has not taken from us this year. A little known fact about UPS is their role in assisting with vaccine distribution over the US, which will boost activity and surely drive up share prices. 

If you like to play it safe then investing in the S&P 500 is a good bet as records show that the index rises EVERY time in December when there is a year-to-date gain of 10 – 15% and no sign of a bear market. These factors assure us the S&P 500 will rise over December into the new year. However, there will be something different this year with the addition of Tesla to the S&P 500 today. Tesla is typically volatile, yet many are seeing their recent rises as an indicator of the broader market. Trading the index this week will be risky, but it might just pay off!

A saying you hear a lot at this time of year on Wall Street is: “if Santa fails to call, bears may come to Broad & Wall.” The seasonal gift of the Santa Claus Rally doesn’t happen every year, but considering what a difficult year it has been, let’s hope that Santa pays us a little visit. Keep up to date with the latest news by following BullBear or visiting our website.

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