Some trading strategies require sophisticated mathematical analysis or powerful computers to develop. But others are so obvious that few investors even notice them, including the experts.
Investing in shares around the end of the month is a good example.
Fans of Random Walk Theory believe the chance of a stock market rise is exactly the same on each trading day. According to theory, if shares rise 58 per cent of the time on April 15, they will rise just as often on April 23.
Random Walk Theory is widely accepted on Wall Street and in the City. But history shows that many widely-believed stock market theories are wrong. Random Walk is no exception.
It is not widely known but the likelihood of a share price rise differs from day to day during the typical month. Some inter-day differences are quite dramatic. Prices rise just 46 per cent of the time on the 23rd of the typical month but 58 per cent of the time on the 15th.
Trends like this are of obvious interest to very short-term day traders.
But the clustering of so-called "good" and "bad" days during the course of the typical month makes this trend useful to longer-term investors as well.
Our graph shows that shares tend to be more profitable around month-end, from the 27th of the typical month to the 6th of the following month. Another profit spike often occurs in mid-month, the 14th and 15th. Both trends have been apparent here in the UK since 1935 when daily price records were first collected on a systematic basis by the Financial Times.
Little has changed in recent years. A similar computation based upon daily price data from the last decade or two would produce a comparable graph to the one shown here.
Profit gaps associated with investing in strong versus weak segments of the average month are huge over the long-run. Let us ignore taxes and trading costs for a moment. A hypothetical investor who only held shares from the 27th to the 6th of the following month since 1935 would have seen a £1,000 start-up investment grow to £206,000.
The same £1,000 investment would currently be worth just £61 if the system was reversed with shares held only during the rest of each month.
It goes without saying that real-world investors are unable to ignore taxes, broker commissions and other trading costs. For this reason, it is difficult for private investors to exploit a trading strategy that attempts to capture intra-month profit abnormalities.
Even so, month-end investing is worth thinking about. Anyone planning to buy shares near the beginning of a month would do well to act a bit more quickly and take action as the end of the prior month approached. Thinking of selling at month-end? Consider holding off for a few days.
This trading philosophy will not produce extra profits every time. But it will provide a significant edge over the long-term.
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