Santa Rally, Window Dressing, and Tax Harvest
At the end of each year, traders become preoccupied with the Santa Rally, window dressing, and tax loss harvesting. Like most things, everything has a time and place. In order to know how to position yourself during this time of year…
Understand these three tendencies…
The Santa rally, window dressing, and tax loss harvesting are seasonal tendencies. Meaning that if you look back over the past five, 10, 15, 20 years… the same types of patterns emerge.
Many traders confuse these tendencies as some kind of “Christmas” occurrence. This is not the case.
These tendencies start to develop at the end of October. In fact, you can use Halloween as a starting point for our discussion.
There are no absolute certainties in trading so this doesn’t hold true for every single year. However, more often than not, as traders play probabilities they are expecting an overall uptrend into New Year’s Day.
The tendency that’s talked about the most is the Santa Rally. The Santa Rally is actually just a small phase of the overall move from Halloween to New Year’s Day.
The moves that we typically see beginning around Halloween and going to nearly Thanksgiving are often pullbacks. Then there’s another frequent move just after Thanksgiving to just before Christmas, where again, there’s another pullback. Lastly, coming out of Christmas, there are five trading days going into New Year’s Eve. Those last five trading days of the year are what’s known as the Santa Rally.
Before we look at the Santa Rally in any given year, we need to look at the window dressing rally.
Window dressing is designed by portfolio managers.
Like any window dressing, these are staged displays. What is in the window is not exactly accurate of what things will look like or what is really happening behind the scenes.
Strong stocks are going to be added to a portfolio at the end of the year to polish the overall holdings of whatever that portfolio manager has designed for their clients.
The idea of window dressing is to show strength while simultaneously reducing holdings and underperforming assets.
This is where the tax-loss selling or tax-loss harvesting comes into play.
By Dec. 31 of each year, it is prudent to sell under-producing assets and use the tax benefit. The other benefit, for fund managers, is that underperforming assets aren’t shown to be prominently held at the end of the year in their client’s portfolio.
Window dressing emphasizes the good while de-emphasizing the negative or weak.
This is the larger phenomenon going on with all three tendencies. The market influence comes from the size and the sheer amount of dollars that these managers wield.
The next logical question is, how can a retail trader benefit from these seasonal tendencies?
Firstly, how do we protect ourselves, and secondly, how do we get opportunistic and benefit from it?
Keep a lookout for next week’s discussion where we will talk about what symbols I’m looking at going into the rest of the year.