How traders could pilot festive market sentiment

AS CHRISTMAS rolls around, many market pundits will once again seek to explain away the typical bull market sentiment as a seasonal anomaly – or indeed, to give it full moniker, a Father Christmas rally. But is this actually something you can hope to trade successfully? Or is this seasonal sentiment nothing more than a good catch-all for the informed to use with the benefit of hindsight – especially when there’s likely to be little in the way of fundamental news to work on at the end of the year?

If you dig through the charts for each of the last 10 years or so, you can by and large pick a date in the run-up to Christmas, and another early in the New Year, and highlight where a broad index like the FTSE managed to tack on a healthy couple of hundred points. But if you are to have any hope at all of trading off the back of this phenomenon successfully, you need to know when to get into the market – and of course when to get out.

This is a classic opportunity for those traders who look to back-testing to validate their strategies. They can get stuck into their Excel spreadsheets, and the specialist back-testing tools that are provided by the bulk of brokers today. But can we pull this approach into a meaningful strategy?

If you bought the FTSE 100 at the closing price on 15 December, then sold again at the closing price on 5 January (or use the first trading day thereafter should either date fall on a weekend), how would you fare? On 11 of the last 12 years, the FTSE rose during this period, providing an average gain of 2.63 per cent. The only year that saw a drop – a modest 0.64 per cent - was Christmas 2006, and had you sold a few days earlier that loss would have turned into a more festive 1.5 per cent gain. Even so, compared with the 7 per cent gain seen in 2008, the generosity of such a rally can clearly ebb and flow.

So what’s causing this move? There are a range of theories in play. Some put it down to fund managers buying up stock going into the year end, while others prefer a looser interpretation. Senior staff are away from the office, while the juniors hold the fort – full of Christmas cheer. There’s not much economic or corporate data to legitimately dampen that festive spirit, so put this all together and it paves the way for a heady combination of bullish behaviour.

As all good disclaimers should read, past performance is not an indication of future results. But playing around with the numbers certainly yields some interesting results at this time of the year. Purists may even want to declare that a Father Christmas rally can only occur between Christmas and New Year. But ultimately for any strategy like this to stand up, you have to be able to declare with some confidence that it will happen ahead of time.

Of course, this New Year’s Eve also has the potential to see the US hit that much talked about fiscal cliff. And with the European debt crisis failing to go away, could the start of 2013 see a fundamental shift in attitudes? I don’t profess to know the answer to that one. But even if I have given up on any hope that the big man in red will shuffle down the chimney this year (with a sleigh full of presents for me), there will be no shortage of traders who will continue to cling to the hope that Father Christmas will keep to his promise and serve up a rally this Christmas. Just like he always does.