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Following Trendy Stock Market Rules? Here's Why its Making You a Worse Investor

Wednesday, February 09, 2022 02:33 PM | Nick Dey

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Following Trendy Stock Market Rules? Here's Why its Making You a Worse Investor

In the fast-flying world of stocks, there’s no shortage of lists and adages that often follow a rhyme scheme. These sayings offer, at most, a modicum of truth that is coupled with a lot of assumptions.

We’ve all heard the saying, “Sell in May and Go Away, and come back on St. Legger’s Day” and last May, we told you about how that advice is dated at best. This phrase is derived from research on the historical performance of the stock market, which showed that the summer months tend to decline.

But, there was no Robinhood (HOOD) or other app-based trading platforms, no cell phones, no internet, and retail investing wasn’t as big of a big phenomenon in the over 100-year history of the stock exchange. So, if you were going on vacation, well, it might’ve made sense to sell in some circumstances because once you got to your destination of Europe in 1952, it was probably really hard to avoid calamity, if it struck.

However, from 2010 to 2019, this trend hasn’t held true as the summer months now average a 2.58% rise. And that is giving a rough hurdle to the stat as a third of those years were directly following the Great Recession. Without those years, there was a 4.74% rise.

So, the phrase correctly identifies a historical correlation but hasn’t aged well, to say the least. But, perhaps, the more interesting part of this is how it directly goes against other stock market mantras: “Buy the dip” and “buy low and sell high”. Both of those would have you believe that the summer is the best time to get into the market, not exit.

So, already, we can see how trying to make black and white out of an infinitely gray market is contradictory and, likely, unwise.

In a report by CFRA’s John Freeman, ironically titled “8 Rules of Investing in Software-based Businesses” (where the first rule is No Rules!) Freeman notes that rules “are not exogenous” and that the market and the rule’s efficacy evolve over time.

Freeman says “As participants join in to follow any rule that produces a profit, their actions steadily dislodge the correlations between the rule and market behavior, eventually sapping the rule of any predictive value - if it ever even had any to begin with”, before bringing it home saying that if you only follow rules, you will ironically “become really bad at picking stocks.”

This is important because, just like how Christmas music starts a week earlier every year, so too can our catchy rules.

The Santa Claus Rally, the September Effect, and all of the rest of them are prone to having buyers try to beat the market. As the phrases become more mainstream, the correlation wanes.

This doesn’t mean it isn’t fun to wonder if there will be a Santa Claus Rally this year or whatever. It also doesn’t even mean that you can’t consider it while buying stocks. But if the buy-case for GameStop is that during the eight trading days following Christmas stocks go up, you should reconsider.

You could take that one step further and say, well, there likely will be pretty low volume during those days and I’ve seen a lot of buzz on Reddit again about buying GME stock with our Christmas money, so I think getting it is a good bet since retail investors will likely have a greater influence on the market.

While I have reservations about blindly following self-proclaimed apes into the market, at least you gave yourself a reason that is only loosely influenced by the rule.

As the great Warren Buffet once said, “It’s only when the tide goes out that you learn who’s been swimming naked.”

So suit up and don’t go blindly following rules because, eventually, the rhyme that brought you dimes will become the rhyme that misguided your investments.

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