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How to Play the Thanksgiving Rally of 2011

The Dow Jones Industrial Average of 30 blue-chip U.S. companies has historically given investors something to be thankful for during the week of Thanksgiving: money.

Buying into what is known as the Thanksgiving Rally could earn you profits that make up for Black Friday shopping on Apple iPhones, Coach bags and Sony LCD TVs. The rally, often used as a short-term trading strategy, was coined after a 35-year trend whereby the stock market would pop on the Wednesday before Thanksgiving Day and the Friday afterward.

Wall Street sign
Wall Street sign

The trend was broken in 1987, the year the market crashed and a decline was recorded on both Wednesday and Friday surrounding Thanksgiving. Since 1988, the stock market recorded gains 14 of 23 times for the combined Wednesday and Friday.

Jeff Hirsch, editor-in-chief of the Stock Trader's Almanac, said "it's important to understand that this is a historically bullish trend that has been derailed in the past by exogenous events."

"Gutsy traders may be able scalp some tidy gains buying into weakness ahead of Thanksgiving and selling into strength on Wednesday before or Friday after," he said. "This year headline risk is especially high."

The lack of a deficit-reduction plan over the weekend sent the market down 249 points on Monday, and it was confirmed after the close on Monday that a planwould not be reached before the deadline of Wednesday. The timing of these actions helps to eliminate this event as a cause to buck the Thanksgiving rally. While the European debt crisis will loom large into the weekend, stocks opening lower today could be a good entry point for those who want to take part in the trade.

ETFs that mimic movements of the broader market, such as the PowerShares QQQ Trust, SPDR S&P 500 ETF or iShares Russell 2000 Index, are popular vehicles to execute the trade.

Warning: The Thanksgiving Rally must be actively monitored. If you get long into the trade today, depending on your threshold for risk, sell into any rally on Wednesday and make sure to exit Friday. Looking at the past 10 years, Wednesday has yielded a better return than Friday in seven of those years. The Monday after Thanksgiving has, conversely, reported a decline in seven of the past 10 years.

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