The Halloween Effect: Ghosts, Ghouls, Goblins and Spooky Math

HalloweenEffectThe Halloween effect just might be more of a trick than a treat – think less chocolate and more witch’s brew. The end of October and beginning of November mark the start of the six-month period of November-April during which, historical evidence shows, stocks have outperformed when compared with their performance during the other six months of the year, May-October, or with the performance of a general buy-and-hold strategy. Indeed, over the past year, the numbers seem to indicate something similar for the U.S. stock markets as per a mutual fund stand-in, the Vanguard Total Stock Market Index Fund (VTSMX) – positive returns of close to 10% from November 1, 2013 through May 31, 2014, as opposed to only a little over 5% from June 1, 2014 through October 31, 2014. This outperformance continues to lend credence to the concept of market timing and fuel the debate over active versus passive investment strategies. And so, with another potential bumper period for stocks possibly about to get under way, we owe it to ourselves to address the topic and speak to why we shouldn’t give the wolf in sheep’s clothing any candy; why it is not advisable to indulge in this active strategy in spite of evidence of a persistent seasonal pattern.

First a quick review of the phenomenon in question. In 2002, Sven Bouman and Ben Jacobsen published a paper in the American Economic Review entitled, “The Halloween Indicator, ‘Sell in May and Go Away’: Another Puzzle.” Therein they presented evidence that stock markets in many countries exhibit a particular strange seasonal anomaly and have been doing so for some time. Six-month returns for stocks for any November-April period tend to outperform the six-month returns for stocks from May-October of any given year, and they tend to outperform the returns from more passive buy-and-hold strategies.

In other words, you could apparently boost your investment returns by buying only stocks sometime around now, holding through April, selling off at the end of April/beginning of May, moving your cash into “risk-free” investments such as T-bills and holding those through October, then selling out of your T-bills and moving back into stocks when the next Halloween/beginning of November rolls around. Rinse, wash, repeat. This sequence explains the two nicknames this phenomenon goes by, suggested by the title of the Bouman-Jacobsen publication. We should note that while they were not the first to take note of the pattern, they were the first academics to analyze it.


Bouman and Jacobsen specifically examined the results from January 1970-August 1998, but three members of the Department of Finance at the University of Miami have since extended the study to 2012 and have found that, according to their methodology, the phenomenon persists. This is rather incredible given the low number of transactions you would have to undertake, meaning low transaction costs, and given the simple fact that other calendar-based active trading strategies have failed to withstand repeated scrutiny or have dissipated after being noticed by market participants.

The persistence of such a trend is troublesome as the the existence of such a distinct, more-or-less easy-to-follow, repeatable, no-barrier-to-entry strategy flies in the face of countless academic financial research pieces, literature, and theories, the personal experiences of seasoned investors, and entire bodies of thinking on lazy, passive, or buy-and-hold investing approaches. It invalidates the wisdom that one should educate themselves on investment matters or rely on sound judgement. However, following such an active strategy would most likely prove even more troublesome one day, and here’s why. Please note these counterpoints are not ranked in any order of priority:

  1. Chasing ghosts: Engaging in such a strategy would violate the maxim that past returns are not an indicator of future results nor can they promise similar future returns. What has come to pass before does not guarantee that it will be repeated.
  2. Tricked by ghouls: Hindsight is 20/20. We only know this pattern to exist in retrospect, we have observed it only after-the-fact. Nobody predicted that this particular pattern would emerge and persist. This is an important distinction – if someone had predicted that this pattern would emerge, we could assume that they utilized some existing evidence and reasoning to arrive at the prediction, that they had actionable information or otherwise read the tea leaves correctly, but instead, we are only aware of the pattern because it has come to pass, which is to say, the pattern exists by chance. Needless to say, chance is not a sound basis for investment decisions.

To expand on this latter point, consider the following “casual observation” made by Edwin D. Maberly and Raylene M. Pierce in their response to the Bouman-Jacobsen paper, “Stock Market Efficiency Withstands another Challenge: Solving the ‘Sell in May/Buy after Halloween’ Puzzle”. Intriguingly, “a preponderance of major economic and/or political events that negatively impacted world equity prices have occurred during the May-October periods.” Specifically, they point out the stock market crash of ‘87 (October) and the catastrophic collapse of hedge fund Long Term Capital Management (August, 1998). After adjusting for these “outlier” events in their regression analysis, they find the pattern to be much less apparent for their stand-in for the markets in the United States, the S&P 500 (when they then adjust for the January effect as well, the pattern dubbed the Halloween effect becomes even that much less statistically significant).


Let’s fast forward from 1998 to 2008. As you can see from the above graph of SPY (the SPDR S&P 500 ETF Trust), you would have avoided the most sickening of plunges in the U.S. markets by paying heed to the Halloween effect. But in the case of any of these three examples, the root causes were long baking in the oven. You would have been hard pressed to find anyone who could have predicted the exact month in which these buildups would have culminated in such dire results. Not to mention that some months out of the off-period may have been positive for stocks but when looking at an entire six months punctuated by such dramatic events as these, those other benign months and their results are overshadowed. This all again smacks of chance – are you willing to bet that a preponderance of such events will continue to occur sometime in the May-October time period into the future?

  1. Feeding your money to the goblins: The reality that this pattern has held many times does not reduce your risk in undertaking said strategy. If it so happens that you engage this strategy on an off year for this phenomenon (and there have been off-years), you will feel the pain of having a non-diversified 100% stock portfolio, i.e. loss of capital and increasing distance between you and your financial goals. There is essentially no room for error and depending on your willingness, ability, and need to take financial risk, you could end up doing yourself a disservice.
  2. The spooky math: The mean standard deviation of returns from such a strategy has been and will continue to be greater than that from, say, a well-balanced and diversified lazy three-fund portfolio that consists of domestic and international equities, bonds, and perhaps other low intercorrelated assets. The volatility of returns on the all-stock portfolio from November-April will be higher. Put another way, the variance of returns will be greater, meaning that the real return can differ from the expected return by a greater amount when all is said and done when compared with the safer alternative. That volatility signifies increased exposure to the risk of not realizing expected returns and can rattle a person more than a fright at the local haunted house.

If you are still feeling the lure of higher returns from a mechanical equity strategy and the costumed wolf still has your ear, realize from our opening example of the VTSMX that you would be up well over 15% if you simply bought and hold the entire year from November 2013-October 2014. Selling in May and going away would have cost you additional positive returns. Otherwise, some words of wisdom from Richard Wyckoff dating back to 1930 might help:

At the time many thought that the market could be beaten by mechanical methods; that is, by some means other than human judgment. [Charles] Dow suggested a few of these. [Roger] Babson had one or more. All kinds of individuals came forward with ways of beating the stock market; each was certain his method would make a fortune. Not long afterward, however, after further study, I decided that methods of this kind, which substitute mechanical plays for judgment, must fail. For the calculations on which they are based omit one fundamental fact, i.e., that the only unchangeable thing about the stock market is its tendency to change. The rigid method sooner or later will break the operator who blindly follows it.

{An earlier version of this article was first published on <>}

Leave a Reply

Your email address will not be published. Required fields are marked *