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Stock Traders Almanac's Jeffrey Hirsch reviews what traders need to know about the Santa Claus rally, and why January is an important month for stocks.

My guest today is Jeffrey Hirsch from Stock Trader’s Almanac, the expert in seasonal trading. We’re talking to him about a really popular one today called the Santa Claus rally. You’ve probably heard of it. Jeffrey, what is first of all the Santa Claus Rally?

Well, I mean that’s important. A lot of people use the term very loosely for any rally that goes from Halloween through January, but really it’s the last five days of the year or the first two of the New Year, the seven-day trading period.

The S&P 500 has produced about a 1.5% gain since 1950. Not anything really to jump and scream about, but the purpose and the importance of the Santa Claus rally is when it doesn’t show up. We have a line coined by my illustrious father: "if Santa Claus should fail to call, bears may come to Broad and Wall."

When there is no rally and that seven-day period is down, you look to have some down market start when it doesn’t show up.

Is it a specific time that according to the Almanac that I should buy on a specific day and sell on a specific day?

It’s less of a trading strategy and more of an indicator of the future course of the market. You can also use it to trade. You want to get in there before Christmas and get out the second trading day of the year. If it is a big strong day, up day, you can trade that period right there.

Most importantly, as I keep trying to say, what if it doesn’t show up? Like in 1999 and 2000, that was the top of the secular bull market. We had it in 2007 and 2008, look at what happened. I mean in 2004 and 1994 we just had a flat year after that. When it doesn’t show up, it means that there is a lack of bullishness that’s normally around at the end of the year, and that’s a warning sign.

All right, how about certain sectors. Is it the tech sector or financials that tend to really react to this?

No, it’s a broad market thing, and it runs in with the first five days of January indicator and then the January barometer. We like to put them all together, and if all three are down—if January is down—you either have a 10% correction, a flat year, a bear market continuing, or a bear market starting.

All down January is followed by either flat to negative years. You combine that with a lack of a Santa Claus rally and a weak first five days, it gives you a strong indicator about what to do with the rest of the year.

All right, and it’s all about ETFs: am I buying a SPY, am I buying small caps? What do you like to do here?

I mean I like to trade small caps using the small-cap effect. You know, the free-lunch practice that we have.

The Russell 2000 has some good action there. I think you can do options on the IWM. You can trade it straight up. You can do options on the Triple IWM (TNA). You can get good action there trading the small caps during that period. I think it’s really a small-cap move.

Related Reading:

Profit Now from January Effect

Yes, Virginia, There Is a Santa Claus

Stuff Those Stockings with Stocks

Tickers Mentioned: IWM, SPY

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