Seasoned professional traders typically understand the theory behind "Sell in May and go away." However, it's not always cut-and-dried.
Sometimes it might be better to hold through the summer, but sometimes it might be better to not only sell but also establish short positions. As we enter the month of May, the question is which it will be this time.
First, the rationale behind this theory is that markets swoon more often than not during summer months. The procedure is to sell in May and buy back in October, or at least after the summer swoon, and avoid the typical summer losses.
However, in recent years this has not been the case. In fact, we have seen solid summer rallies in the recent past, since the credit crisis, and this has made the old adage lose credibility. There was a reason for that, though — a reason that does not exist today, and one that might make this summer look more normal than last year, at least.
Since shortly after the credit crisis, central banks have been pouring approximately $60 billion per month into global equities. When they do that during the slower summer season, it can bolster stocks and completely counter the typical summer doldrums. This has been the case for years, but this year that is no longer true. The Federal Open Market Committee and the European Central Bank are not only no longer offering a combined stimulus, they are a net drain on liquidity for the first time since stimulus was first introduced by former Fed Chairman Ben Bernanke.
With that, this summer is shaping up not only to be more like normal, but probably worse than normal. If liquidity levels are less than normal, the probabilities suggest that this summer should also be worse than normal.
Initially, that may sound like short positions may be the best idea, but there is another option. Sure, if the market is weak, we can make money from simple short-based exchange-traded funds, such as DXD, SDS, QID and TWM. However, when markets are weak, volatility levels are also usually high.
Higher-than-normal volatility levels suggest we can do more than just take advantage of short side moves. It's possible to benefit from buying dips, too, so long as everyone remembers that short-term gains lead to long-term success. Long ETFs would be used for that, so DDM, SSO, QLD and UWM, respectively.
This year has offered opportunities on both sides, and although this summer is shaping up to be weaker than usual, we expect it to provide opportunities on both sides, too.
The "Sell in May" theory seems like a no-brainer this year, but we can do more. It's possible to make money while everything else flounders. The upcoming volatility can be embraced and treated opportunistically as a result.
— By Thomas Kee, president and CEO of Stock Traders Daily