Forex Seasonality and the Yearend Effect

12/14/2015 9:00 am EST

Focus: CURRENCIES

Adam Lemon, of DailyForex.com, looks into if there has been any seasonal behavior of currencies exhibited from a study of the last 36 years of historical data and answers whether these results are valuable and if so, how they might best be utilized by forex traders as a seasonal forecast in order to make a profit.

Forex seasonality is the term used for the tendencies that certain currencies might have exhibited to move in particular directions at certain times of the calendar year. Are there any seasonal patterns that have influenced forex markets? For example, if the US dollar shows a tendency statistically to increase in value during the month of March across a sample of many years, then we could say it has a seasonal tendency. Many studies have been done investigating forex seasonality, although you might wonder whether it is worth it. In this article I am going to look into whether there has been any seasonal behavior of currencies exhibited from a study of the last 36 years of historical data and explain what any such tendencies might plausibly be caused by. I will conclude by explaining the weaknesses of such studies and question whether these results are valuable and if so, how they might best be utilized by forex traders as a seasonal forecast in order to make a profit.

Seasonal Forex Tendencies

If we look at a fairly large sample of data, we may be able to identify some seasonal currency behavior. The largest data range available to me was looking at the US Dollar Index and the more major other global currencies against the US dollar over a period greater than 35 years. Several seasonal tendencies could be identified quite clearly.

The US Dollar Index tends to perform strongly in January and falls in a pronounced manner during the final quarter of the year, in fact from September.

The euro, British pound and Swiss franc behave in a nearly identical manner and in the mirror image of the US Dollar Index, they perform poorly in January, then rise from September through until the end of the calendar year.

The Japanese yen rises from August to October. It tends to perform most poorly in January and best in September.

The Canadian dollar is more erratic, performing most poorly during the months of July and November and most strongly during June.

Interpreting Forex Seasonal Tendencies

What stands out the most from this review is a yearend effect that could be used in a seasonal forecast: the USD falls as the yearend approaches, then takes off in January as a new calendar year starts, with the other currencies mostly mirroring this move. Is there a plausible explanation as to why this seasonality should happen? There is, as the end of the calendar year provides an anchoring bias, as well as being a key deadline for taxation and reporting. Funds and money managers usually report performance by calendar year, meaning that losers will be trying very hard to win and winners will be trying very hard not to lose more and more as the yearend approaches. This could provide fuel for strong trends and there is an old traders’ saying the December is usually either an awful or wonderful month to make profit in the markets.

NEXT PAGE: The Two Areas of Concern

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Taxation issues should not be ignored, as taxation on profits and losses are levied in the USA and in many other countries on a calendar year basis. As many tax systems allow losses to be written off against profits from a previous year, there can even be a good reason for holders of losing positions to liquidate those positions before the end of December and then buy them back once January begins, in spite of the transaction cost.

The next area to examine should be whether there is are any seasonal factors that drive the economies of any of the currencies’ countries. Of the currencies reviewed, the only commodity currency is the Canadian dollar, which is quite positively correlated with the price of crude oil. However, industrial use of crude oil dwarfs any personal consumption, so we could not expect winter to have any seasonality effect and, in fact, it does not anyway. I do not see any evidence based upon this study of particular seasonal behavior of currencies.

Methodological Weaknesses

Before getting too excited at the potential advantages of the seasonal effects we have identified in this study, we should question whether or not what we have here is convincing enough to use within a seasonal forecast with confidence. There are a two areas in particular that should concern us:

  1. The currencies measured, with the exception of the US Dollar Index, have been measured only against the USD and not as fully weighted baskets against a range of currencies.
  1. Although we have looked at more than 35 years of data, it is questionable whether that is enough to give a truly representative and meaningful sample. Most financial statisticians would argue that at least 200 samples are required and we only have about 35.

 

Utilizing Seasonality

Seasonality should not be the basis of any trading strategy and I would never make a seasonal forecast. However, there is evidence that the end of the calendar year has a tendency to produce directional movement, while the summer months tend towards an absence of such movement. Trend traders can utilize seasonality by putting greater weight on trend trades that occur towards the end of the calendar year, and conversely, putting less size into such trades during the summer months. This can be done without holding to dubious forecasts of exchange rate seasonality.

By Adam Lemon, Contributor, DailyForex.com

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