This is the time of year when it seems like everyone is talking about a “Santa Claus Rally.” According to Investopedia, the concept of the Santa Claus Rally describes a spike in stock prices over the week between the Christmas and New Year’s holidays.
There are a number of factors that get credit for this spike, including tax purposes, people investing their Christmas bonuses, and bears taking the week off. Investopedia also suggests that the spike in stock prices is likely due to investors moving into stocks because they are anticipating a January rally.
As quantitative traders, we are able to see that many of these conversations are based on selectively bullish memories that are dramatically skewed towards recent years. Are there really any significant numbers to support the idea of a Santa Claus Rally?
Jeff from System Trader Success published an interesting article that takes a strictly quantitative look at how the S&P 500 has traded over the ten days before and after Christmas since 1964.
Jeff’s Christmas Trade Strategy
In order to first test the concept of a Santa Claus Rally, Jeff wrote a simple system that started with $50,000 and would risk 2% of its capital on a long SPX trade every Christmas season. He defined the risk on a trade as three times the 10-day average true range of the SPX.
To determine the best entry date for his strategy, Jeff tested the performance of SPX based on purchases made between one and ten days before Christmas. He used the same idea to determine an exit date by testing the performance of SPX between one and ten days after Christmas.
The performance before Christmas was positive regardless of the entry date, but the performance improved with longer dates. The post-Christmas results were very similar with longer hold times generally performing better. Jeff elected to go with five days before Christmas as his entry and five days after Christmas as his exit.
Backtesting the Strategy
Backtesting Jeff’s strategy over 48 potential Santa Claus Rallies produced a net profit of $23,964 on his $50,000 capital. The strategy recorded a win rate of 79% and an average profit of $499.
In a simple attempt to improve the strategy’s performance, Jeff also tested implementing a trend filter using the 200-day simple moving average. Only taking the Christmas trades that occurred during bull markets eliminated 16 trades. On the remaining 32 trades, the win rate jumped to 81% and the average profit jumped to $566.
Surprisingly, the results of the 16 trades that occurred during bear markets were not terrible. Those trades recorded a win rate of 75% and an average profit of $365.
What About This Year?
How would trading Jeff’s Christmas strategy have worked this year?
As you can see, five days before Christmas the SPX had a big up day. If the system would have been able to buy at the open on that day, it would be sitting on more than a 3% profit with three days left until it exits.
One of the most interesting aspects of this strategy is that it only employs your capital for 10 days every year. This means that it won’t make a great strategy on its own, but could be very possibly be worked into another strategy.