The vast majority of investors base most of their financial market research on one or both of two primary general methods: technical analysis and/or fundamental analysis. Technical analysis involves the analysis of price charts and other indicators related to price movement. Fundamental analysis involves the analysis of hard data such as earnings and sales for individual companies, or specific supply and demand data for commodities. There is however, a third choice known as seasonal analysis. In January of 2009, John Wiley and Sons released my latest book, Seasonal Stock Market Trends. Borrowing heavily from pioneers in the field of seasonal analysis such as Yale and Jeffrey Hirsch, Norman Fosback, Peter Eliades and others, the book analyzes and highlights a wide variety of seasonal trends that have been in effect in the stock market for the past forty to one hundred years.

In the final section of the book I pull together thirteen seasonal trends into something I refer to as the "KTI," which stand for the "Known Trends Index" (it was either that or "Kaeppel's Totallyexcellent Index," which seemed just a bit over the top, even for me). While the trends themselves are spelled out in the book, suffice to say, "t'ain't exactly rocket science." For example, one rule reads "if today is between the first trading day of November and the third trading day of May then +1." Another rule states, "if today is a trading day in September then -1." All of the other eleven measures are just about as equally, er, "sophisticated."

Basically, the KTI simply totals up how many of the trends are bullish on a particular trading day. If a particular trend happens to be bullish on a given day, then one point is added to the KTI for that day. Theoretically, the KTI can range anywhere from -1 to +12 (one of the trends can only register a bearish reading and if so one point is subtracted from the KTI). In reality, the highest reading ever recorded for a single day was +8.

While all of this may sound like a lot of mumbo jumbo up to this point, the net effect of analyzing daily KTI readings is nevertheless quite compelling. Table 1 displays the average daily return registered by the Dow Jones Industrial Average based on daily KTI readings. It also displays the annualized rate of return that would be achieved if the daily return was extrapolated over one full trading year in order to illustrate the true strength of weakness experienced by the stock market in conjunction with a given KTI reading.

Table 1 - Stock Market Performance
at Different Know Trends Index [KTI] levels
(1933-2009)

There are two key things to note.

1. First, note that stock market performance improves with every successive higher KTI reading. This type of uniform improvement from one level to the next is a sign of good reliability for any form of market analysis.
2. Secondly, note the difference in market performance at the two extremes. KTI readings of less than +2 have historically been accompanied by declining stock prices. This is especially significant given that during the test period (December 1933 into April 2009), the Dow essentially rose from 100 to 8,000, a gain of 7,900%. At the other end of the spectrum, KTI readings of +5 or more have seen the stock market advance at an annualized rate of +37.2%.

Chart 1 displays the growth - or perhaps more accurately, the destruction of - $1,000 invested in the Dow Jones Industrial Average since 1933 only on those days when the KTI registered a reading of less than +2. As you can see, the results are devastatingly bad. Investing $1,000 in the Dow only when the KTI stood at -1, 0 or +1 since 1933 would be worth about $38 and change today. This represents a loss of about -96% (it bears repeating that during this timeframe the Dow gain about 7,900%.

 

Chart 1 - Growth of Equity when Known Trends Index [KTI] <= +1

While many claim that market timing is a losing game, from the results displayed in Chart 1 it could be argued that there is simply no good reason to be in the stock market when the KTI registers a daily reading below +2.

At the other end of the spectrum, Chart 2 displays the growth of $1,000 invested in the Dow Jones Industrial Average since 1933 only on those days when the KTI registered a reading of +5 or more. The results are quite impressive given the consistent nature of the advance.

 

Chart 2 - Growth of Equity when Known Trends Index [KTI] >= +5

Also note that the results depicted in Chart 2 reflect only the time spent in the stock market with no interest earned while out of the market. This is significant because if you only invested in the Dow when the KTI was +5 or more you would only have been the stock market about 15% of the time. If you factor in any interest earned over the past 75+ years the other 85% of the time you would generate a much greater return, thanks to the magic of compounding.

Summary

As I mentioned at the outset, the vast majority of investors base most of their financial market research on one or both of two primary general methods - technical analysis and/or fundamental analysis. Nevertheless, I have found that the analysis of seasonal trends can greatly enhance an investor's ability to identify those periods when the stock market - and many other financial and physical commodity markets - is more likely to exhibit strongly bullish or bearish trends.

The results depicted herein would seem to back up that claim.

NOTES: 

I will be teaching a session on Seasonal-based trading at this year's Optionetics OASIS, June 18-21. I look forward to seeing many of you there. For more information about this incredible event, please click here.

To learn more about Seasonal Stock Market Trend: The Definitive Guide to Calendar-Based Stock Market Investing, please click here.

To sign up for a free 1-month trial of Optionetics ETF Investor newsletter - edited by Jay Kaeppel and Clare White - you can do so by clicking here. 


Jay Kaeppel
Staff Writer and Trading Strategist
Optionetics.com ~ Your Options Education Site