How to Buy Stock – Market Folklore

Last year (2011) the stock market fulfilled some of the longstanding folklore sayings which some believe are predictors of market activity.

What are these sayings and should you pay heed? Since I’m trying to get my 401K proceeds re-invested in my IRA, I’m particularly interested in some of these and decided to explore them and report back to all of you.

Sell in May and go away.

The idea of this bit of folklore is that the market does best in the months of October through May so if you sell in May you are getting a higher price and can then buy back at a lower price after the market dips through the summer.

Charles Biderman, in Forbes, reports that for the past TWO years, stock markets dipped following May and he anticipates this year following suite. On the other hand, Alex Dumortier, at the Motley Fool shows us two versions of historical data analysis that proves that buy and hold strategies are more successful than selling in May and re-purchasing in October.

However, there is also folklore which says that in a presidential election year, the market will go up, even after May – because the incumbent wants to get re-elected and will do anything and everything to make sure the economy is doing well. This is called the Presidential Election Cycle Pattern.

Why do I care? I want to buy some stocks, but they are at their personal best right now and I’d like to get them at a lower price. Since it is already mid-May, I probably will set some buy limits (name a price at which I want to buy the stock) with my brokerage firm and let them ride (i.e. set a ‘good until cancel’ buy limit). So far this month seems to be living up to this saying!

Sell in the Santa Claus rally.

This is a rise in the price of stocks occurring in the week prior to the beginning of January. The rise is attributed to multiple influences, such as making sure certain transactions happen this calendar year for tax purposes, anticipation of the “January effect” (see below), people investing their Christmas bonus (wait, do they still give those??) or fund managers preparing their holdings for the annual reports (changing out the stocks they hold to make sure the annual reports look good to investors – called window dressing).

If you need to sell, watch for the rally starting the last week of December. If you need a capital loss, sell your losers before that!  I’m hoping to lessen a position in one particular stock to limit risk so I will be watching to sell on a profit.

Beat the January effect.

Prices rise in the month of January, theoretically because individual investors sell in December to take gains or losses for tax purposes, then buy back in January. I have trouble with that theory because I don’t believe that individual investors have that big of an impact on the market anymore.

As goes January, so goes the year.

If we have a rising market in January, the market will be up at the end of the year.

According to the Wall Street Journal, “In years when the Dow has risen in the first month of the year, the median rise for the rest of the year is 10.4%. In years when the Dow has fallen, the median rise for the next 11 months is just 0.28%. “

The markets (at least the S&P) did finish up about 4% in 2012.

The market hates uncertainty.

Although nothing is ever certain, when there is turmoil in the economy or in political or other situations, the stock market can be affected. In 2011, we had a roller coaster ride up and down and all around with stock and bond prices bouncing all over the place.

Uncertainty in the world and US economic situations were blamed. Political turmoil, financial crisis, terrorist strikes, war and even civil disobedience can trigger reactions in the market. Waiting to buy on a dip caused by uncertainty is one way to chase lower prices.  These days, its one that isn’t too hard to implement!

Avoid buying the dividend.

A dividend paying company first declares the dividend (Declaration date) – which causes them to set aside the funds to pay the divided and lets the world know that they will be paying one.

Then the company sets the date by which you have to own shares to get the dividend (Record date – you have to be an owner of record to get the dividend). After this the stock trades without the dividend – meaning that if you buy the stock after this date and before the payable date, you don’t get this dividend. This is called the ex-dividend date or period (ex meaning without).

When the dividend has been declared and is in it’s ex-dividend period, the price of the stock usually drops to compensate for the dividend to be paid out.

Finally the company actually pays the dividend to the shareowners of record (Payable date) and then the cycle starts all over.

If you buy a stock after a dividend declaration has been made, but before the ex-dividend period, you will receive the dividend – however the stock price will fall because the market understands that the company is shedding some income which it could have used to grow. You will receive a dividend. You will have to pay taxes on the dividend (unless of course you hold the stock in a tax deferred account) and the price of the stock will drop after you buy it.

Why not wait for the stock price to drop,then buy it during the ex-dividend period. You get a cheaper price and avoid the income tax penalty.

Do you believe in these folklore sayings?

I’m certainly not an investment expert or professional, so don’t base any investment decisions on me. I tend to think that folklore has some validity, and its ‘truths’ may actually be true about half the time!

The bottom line for me is to know what allocation I want, research the types of investments and explore the strengths of individual companies before investing. While I don’t ignore price and timing, I don’t pull the trigger on making or selling an investment based on them either.

What Market folklore has merit in your mind? Have you heard other sayings?