In this article, we will focus on an interesting aspect of the US stock market, analyzing the performance of the Dow Jones Industrial Average in the first six months of the year and its influence on the remaining six months. The goal is to answer the following question: if the market has shown a positive performance in the first six months of the year, what are the implications for the following months? In other words, we will explore whether this performance can be a good indicator for expectations for the months that follow.
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Importance of Dow Jones and Strategy Assumptions
The Dow Jones Industrial Average ($INDU) is one of the most important indices globally. Founded in 1896 by Charles Dow, this index was designed to summarize the health of the US stock market through a basket of 30 stocks, mainly belonging to the industrial and financial sectors. Although it has undergone changes in terms of composition over the years, it remains a point of reference for traders and investors.
For this analysis, we will focus on historical data of the Dow Jones from 1920 to today. By considering over 100 years of history, we will be able to analyze the pattern of our interest over a period characterized by different economic phases, including recessions and wars. Analyzing only the last few years would not be entirely correct, since the results could be influenced by the strong bullish trend we have witnessed. Furthermore, by making only one entry per year, it is necessary to broaden the backtest to have a more reliable statistical sample.
Developing a Dow Jones trading strategy based on the performance of the first six months of the year
Let’s now proceed with the implementation of this strategy. After calculating the performance of the index in the first 6 months of the year, we will enter the position on the first day of July, provided that the performance is positive. As for the closing of the position, this will happen on the first day of open markets of the new year.
The example in Figure 1 illustrates how trades are managed according to the rules just described. It is important to note that, although entries and exits occur with a delay of one daily bar, this obviously has no impact on the results of the backtest, since the position remains open for six months. Finally, to better understand the results that we will see later, it is important to consider that the Dow Jones has recently reached a value of about 40,000 points. To optimize the granularity of the positions and effectively manage the invested capital, we will set a capital of 1,000,000 dollars for each trade, for purely academic purposes.
Figure 1. Example of a strategy trade with long entry after the first day of July and exit after the first day of the following year.
Analysis of the results obtained by buying only when the first six months were positive
Looking at the results illustrated in figure 2, we can see that the equity line, despite the different economic phases and market fluctuations experienced over the last 100 years, has maintained a remarkable constancy. This suggests that the analyzed pattern has demonstrated significant stability during the period considered.
For the average trade, shown in figure 3, the value is $55,000. Considering that we set a capital of $1,000,000 for each trade, this corresponds to approximately 5.5% of the capital per trade, a remarkable result given the limited number of rules used, but in line with the time spent on the market by the strategy.
So if in the first six months there was, for example, a 10% increase, it is reasonable to expect an average return of 5.5% (without considering the reinvestment of profits) in the next six. Furthermore, we can note by analyzing the Percent Profitable item in figure 3, that this strategy has a success rate of 75%: out of 64 total trades, 48 were closed in profit.
Figure 2. Equity line of the Dow Jones strategy with long entry when the performance in the first six months is positive.
Figure 3. Total Trade Analysis of the Dow Jones strategy with long entry when the performance in the first six months is positive.
Test of the opposite logic: Buy when the first six months have been negative
To obtain an objective comparison on the effectiveness of this pattern, it may be useful to also examine what happens when opening a long position in July when the first months of the year have been negative. By changing the entry condition, in figure 4 we can see a significantly lower result: the equity line is clearly less linear than the one obtained previously. Furthermore, looking at the Total Trade Analysis in figure 5, we see that over the years fewer trades have been made, namely 50 compared to the 64 seen previously. This is quite understandable given that the bullish trend of the index, in this case, has led to fewer opportunities to open new positions. Furthermore, the average trade shows a much lower value than the previous strategy, with a worsening of over 50%, going from $55,000 to just $23,000. This deterioration underlines the effectiveness of the strategy based on the positive performance of the first six months of the year, confirming its positive impact on the remaining six months.
Figure 4. Equity line of the Dow Jones strategy with long entry when the performance in the first six months is negative.
Figure 5. Total Trade Analysis of the Dow Jones strategy with long entry when the performance in the first six months is negative.
Final thoughts on the results and why the performance of the first six months influences the rest of the year
In this article we have highlighted how in the stock markets it is possible to profit from a bullish trend in the second phase of the year, following a positive performance in the first phase. At this point we can formulate several hypotheses to explain the effectiveness of this pattern. First of all, it must be considered that it could be influenced, in part, by the seasonal bullish effect that is observed in the last months of the year, in particular October, November and December.
At this point we leave it to you to investigate this seasonal effect, considering for example the performance from January to September, and then profit from the bullish trend of the last three months of the year.
But the most logical explanation could be related to investor psychology, which as we know plays a fundamental role in financial markets. In fact, if the first months of the year have been negative, investors could adopt a more cautious attitude, thus negatively influencing future performance. On the contrary, if the first months have been positive, general optimism could lead to a greater inclination to invest, contributing to a positive performance in the second half of the year.
In conclusion, despite the different hypotheses to best interpret the numbers and the attempt to explain why a positive performance in the first six months of the year can favorably influence the following months, what matters most is to make the most of the information obtained from today’s analysis. Based on what we have observed, we can expect a positive performance for the second half of 2024, given the performance of the first six months, but only time will tell.
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Until next time,
Andrea Unger