Various Seasonality

Does the Turn-of-the-month Effect Affect the Stock Markets?

Anton Volkov 03 June 2022 269 4

The turn-of-the-month effect is one of the most famous calendar anomalies in the stock markets. This anomaly refers to a stock's upward trend over a short period of time between the end of one month and the beginning of the next month.

 

There are many assumptions about the causes of the turn-of-the-month effect. They can be grouped into 3 main hypotheses:


  • Liquidity hypothesis. The turn-of-the-month effect is explained by the appearance at the end of each month of a significant amount of free liquidity in the market, which leads to the growth of stocks. Free liquidity appears as a result of employees receiving wages, dividends, interest income and other payments. Most of these cash receipts historically fall exactly at the end of the calendar month.


  • Hypothesis of macroeconomic announcement. Most US macroeconomic statistics are historically released in the first half of each month. Accordingly, before the publication of statistics, the market pre-sets certain expectations in the price of assets, usually positive ones. After the publication of statistics, profit is fixed, which leads to a drawdown of the market. Further, expectations of statistics for the next month begin to be included in prices, and the cycle repeats.


  • The “window dressing” hypothesis. Investment funds, in order to attract new clients, are directly interested in showing high financial results on each reporting date. To this end, they can “overclock” the desired stocks before their reporting. After the publication of their results, the funds, as a rule, rebalance their portfolios, and especially “overclocked” stocks go into correction.
Hypothesis
To conclusion

Using the turn-of-the-month effect in the stock market brings profit.

To conclusion
Data used

Historical data of quotes of world stock indices:

  • US: Dow Jones 30, S&P 500, NASDAQ 100
  • Germany: DAX 30
  • France: CAC 40
  • Japan: Nikkei 225
  • UK: FTSE 100
  • Russia: MICEX, RTS

Timeframe - D (daily)

Period - from 1990 to November 2021

There are 382 month shifts in total.

Strategy


Opening a position - buying an index on the opening of a 6,5,4,3,2 daily candlestick before the end of the 1st month

Closing a position - selling an index on the closing of the 2,3,4,5,6 daily candlestick after the start of the 2nd month

 

There are 25 combinations of entries / exits from the market.


Analysis of the obtained results 


We will evaluate the results according to the following criteria:


  • The rate of return reflects the relative change in the quotations of financial instruments in percentage. A positive value of the rate of return indicates the profitability of the strategy, negative - about the loss.


The rate of return (R) of a financial instrument is calculated using the formula:


R = Σ P (%) / n,


where: 

n is the number of transactions;

P (%) – ((position closing price - position opening price) / position opening price) * 100%

 

  • The average rate of return of profitable transactions (Dp) includes the rate of return of only profitable transactions, as a percentage:

 

Dp = Σ D (+) / n,

 

n is the number of profitable transactions;

D (+) – rate of return of profitable transactions.

 

  • Average drawdown (AD) reflects the average loss when closing losing transactions for the entire trading period, as a percentage. The smaller the value of the average drawdown, the smaller the losses, and the better the trading signal works.

 

AD = | Σ D (-) / n |

 

where:

n is the number of losing transactions;

D (-) – rate of return of losing transactions.

 

  • Maximum rate of return (MaxD) is the maximum profit from closing successful transactions for the entire trading period, as a percentage. The higher the maximum rate of return value, the better the trading signal works.

 

MaxD = max (D)

 

  • Max drawdown (MaxDD) is the maximum loss in percentage terms from fixing losing transactions for the entire testing period. The smaller the value of the maximum drawdown, the better the trading signal works.

MD = | min (D) |



For changeable parameters, the following notation is used:

O: 6, 5, 4, 3, 2 - daily candlestick, on which the position is opened, until the end of the month 

C: 2, 3, 4, 5, 6 - daily candlestick, on which the position is closed, from the beginning of the month 

 

The example: O2 C5 means that the parameter is calculated under the conditions of opening a position on the 2nd daily candlestick before the end of the month and closing the position on the 5th daily candlestick after the beginning of the next month.

The highest rate of return is achieved with parameters O6 C5. During the analysis of the results, the following patterns were revealed:

  • An increase in the number of the candlestick for entering a position leads to an increase in the profitability of the strategy.
  • Increasing the number of the exit candlestick to C5 inclusive leads to an increase in the profitability of the strategy. Using the 6th candlestick as the moment to exit the position no longer leads to an increase in profitability.

The average rate of return of profitable transactions increases with the increase in the time spent in a position. Accordingly, the highest rate of return level is achieved with the parameters O6 C6. A rate of return decrease with the position closing parameter C6 compared to C5 according to this indicator has not been found.

The average drawdown level shows a trend similar to the average rate of return of profitable transactions: growth along with an increase in the time spent in a position.

The indicator of maximum rate of return does not demonstrate a clear dependence on changes in the entry-exit parameters. The minimum value of 14.92% is achieved at the O2 C2 parameters, similar to the average rate of return and the average rate of return of profitable transactions. The maximum value of 27.32% is achieved with the parameters O4 C2.

The maximum drawdown level shows a trend similar to the average rate of return of profitable transactions and the average drawdown: an increase along with an increase in the time spent in a position.



At the level of individual indices, the results of the Russian MICEX and RTS indices are significantly different from others. The reason is the historically high volatility of the Russian market, as well as the low levels from which trading has begun.

The MICEX and RTS indicators significantly distort the overall picture. To understand how the optimal entry/exit parameters will change, we will carry out calculations in the absence of Russian indices in the sample.


The calculations have shown that in the absence of MICEX and RTS, the general logic does not change: with an increase in the time spent in a position, the profitability also increases. But now, for the parameters O6 and O5, the rate of return is the same, i.e. the distance of the entry candlestick to the position from the end of the month has its own limit of efficiency growth. Otherwise, the turn-of-the-month effect would not differ in its action from the usual “buy and hold” strategy.

In terms of entry/exit parameters, the picture in the context of individual indices is as follows:

  • The best options for entering the market are on the candlesticks 6 and 5 before the end of the month. The result corresponds to the average data for all considered indices.
  • The best option to exit the market is on candlestick 5 after the start of the next month. But in this case, the range of values ​​is higher: the best exit option for the RTS and Dow Jones is the candlestick 6, for the S&P 500 - the candlestick 4, for the German DAX - the candlestick 3, for the Japanese Nikkei - the candlestick 2.


Best entry/exit parameters for stock indices:


Index
Entry candlestick
Exit candlestick
MICEX
6
5
RTS
6
6
CAC 40
6
5
NASDAQ
5
5
DAX
6
3
FTSE
6
5
S&P500
5
4
Dow
5
6
Nikkei
5
2
Conclusion

Using the turn-of-the-month effect in the stock market has shown high efficiency. The greatest profitability of the strategy is achieved when opening a position on the 5th or 6th candlestick before the end of the month and closing the position on the 5th candlestick after the beginning of the next month.


The effectiveness of applying the turn-of-the-month effect in the stock market has been identified.

Detailed results are shown in the Appendix:

XLSX (0.08 MB)Turn-of-the-month effect.xlsx

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