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The Best One-Week Buy Signal Starts NOW

October has a reputation as a nasty month for stocks, but this year’s version has been especially nasty. Through the end of trading on Wednesday, October 25, the major U.S. stock indices are down as follows:

Stock Index

Percentage Return Through October 25

Russell 2000

-13.4

Nasdaq-100

-11.0

S&P 500

-8.9

Dow Jones Industrials

-7.1

Source: Bloomberg

Although the mother of all bad Octobers occurred in 1987, 2018 is a midterm election year and so far October 2018 is the worst midterm election year October for stocks since 1978 when Jimmy Carter was in the White House and the Bee Gees were at the top of the pop music charts.

Watching your brokerage account perform a disappearing act feels awful and you may be thinking that now is the time to cut your losses and hide under the bed.

Understandable, but you could not be more wrong.

Consider these historical facts from market pundit Ryan Detrick:

  • Since 1950, there have been seven other years where stocks ended September positive year-to-date but then saw the S&P 500 turn negative year-to-date during October. The good news is that stocks rose during the final two months of the year six of those seven times by 4.1% on average.

  • Going back to 1934, there have been 21 midterm election years. If you had bought the low October close for the S&P 500 in those years and held until the end of the year, the S&P 500 was higher every time. In fact, four of the past five midterm election years going back to 1998 experienced double-digit percentage gains.

Still want to hide under the bed? I didn’t think so.

In fact, based on recent history, the best time of the entire year to buy stocks for a one-week holding period starts right now on Friday October 26 according to option trading legend Larry McMillan. He discovered a time period during late October during which stocks almost always go up:

“Traditionally, this is one of the best seasonal trades to be found. It is a simple concept, based on observing historical price patterns…buy ‘the market,’ which we define as the S&P 500, at the close of trading on October 27. Sell your position out at the close of trading on November 2.”

If October 27 lands on a weekend, like it does this year, the rule is to buy the S&P 500 at the close on the Friday preceding the 27th. This year, that means buying the S&P 500 on Friday October 26 at the market close. November 2 lands on a Friday this year, which is the perfect end date for option trading since stock options expire on Fridays.

Starting in 1978, which makes sense to do since October 2018 is acting similarly to October 1978, stocks during this five-day period did not decline for 23 consecutive years through the year 2000.  For those that like to sell put options as a way to generate income, such a long-term record of success is the Holy Grail because put selling does not require a stock price to rise to make big profits – all it needs to ring the cash register is for stocks not to decline.

Since the turn of the century, the track record of McMillan’s late-October market-timing system is less stellar but still good with 10 out of 17 years between 2001 and 2017 showing gains during this five-day period.

The fact that this pattern has worked less well in the recent past reminds me of a quotation from financial journalist and trader Jon Markman, who wrote in his 2003 book “Swing Trading” that stock patterns often lose their predictive force over time after they have been discovered:

“Like the locked-down rules of convention or science found in law and physics texts, the rules of stock investing begin from a steady and sensible base. But the rules can also mutate quickly, paradoxically, and capriciously. Nimble, experienced traders who observe and act upon these rule changes with ease extract huge sums of money from the market. Investors who instead play strictly by a fixed set of rules – however useful and immutable they might once have seemed – are often their chastened counterparts, the losers of that money. I’ve been frustrated by those ever-changing cycles which, with increasing speed, turn once-useful insights into useless trivia.”

So why am I still so excited about this market-timing system given its recent mediocre track record?

Because I have dug into the data and found a wrinkle that turns even the last 17 years into a money-making machine using this system.

The wrinkle is understanding how stocks perform during October before the October 27th entry time commences. If stocks have risen from the end of September through the market close on October 27, the chances that the five-day period from market close on October 27 to market close on November 2 will be positive are greatly reduced. Six of the seven losing years for the market-timing system since 2000 occurred when stocks had risen during this first part of October.

First Part of October Through the 27th is Positive for S&P 500

Year

S&P 500 Performance Through October 27

S&P 500 Performance From October 27 Through November 2

2001

+6.1%

-1.6%

2006

+3.1%

-0.7%

2007

+0.6%

-1.7%

2009

+0.6%

-1.9%

2011

+13.5%

-3.6%

2017

+2.5%

-0.1%

Source: Bloomberg

On the other hand, if stocks have fallen from the end of September through October 27, the chance that stocks will subsequently rise is almost flawless. Four of the five years since 2000 that stocks fell during the first part of October, the market-timing system made money. The only exception was 2016 during an anxious presidential campaign and stocks subsequently skyrocketed for several months thereafter.

 

First Part of October Through the 27th is Negative for S&P 500

Year

S&P 500 Performance Through October 27

S&P 500 Performance From October 27 Through November 2

2005

-4.1%

+3.0%

2008

-27.2%

+13.8%

2012

-2.0%

+0.2%

2014

-0.5%

+2.9%

2016

-1.6%

-1.7%

Source: Bloomberg

Since stocks have fallen sharply so far in October 2018, chances are good that buying the S&P 500 at the close today and holding until the close next Friday – or alternatively simply selling puts – will generate profits.

How did the S&P 500 perform during the late October period back in 1978, which is 2018’s doppelganger? It rose 1.1%, which in today’s terms would mean a 29-point gain.

Bottom line:  Today at the market close is probably a good time to put money to work in the stock market.

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