Does Turn-of-the-Month Stock Trading Work for Crypto?

What is Turn-of-the-Month Seasonality?

Seasonality in a time series can add new layers of complexity to financial data. Do trading volumes spike at specific times of the day? Are certain days of the week more volatile than others? Do stocks perform better during the end of the year? Understanding and anticipating seasonality can give rise to interesting edges in the market.

One study of seasonality in stocks dates to the 1980s. The authors used 90 years of daily data on the Dow Jones Industrial Average (DIJA) to test for several seasonality effects, including one called the turn-of-the-month effect (TOTM). The idea is simple: stocks usually increase during the last 4 days of the month and into the first 3 days of the next month.

We investigated this anomaly on the S&P 500 with the following trading rule: go long on the fifth to last trading day of the month and close the position on the third trading day of the next month. Therefore, this type of strategy is only active 7 days per month (84 days per year) which amounts to around 33% of the time (considering trading days only).

Since 1960, the compound annual growth rate (CAGR) values of the TOTM strategy and a buy and hold benchmark are not too dissimilar considering the TOTM strategy is only active 33% of the time (Table 1). Notably, the maximum drawdown is almost halved.

So, the seasonality seems to hold for the S&P 500, but does this translate to cryptocurrencies?

Applying the Turn-of-the-Month Strategy to Cryptocurrencies

We applied the same trading rule to a selection of the largest (by market cap) cryptocurrencies. Note, the length of the price history for each of the cryptocurrencies is different due to the difference in the inception date of each coin. We ensure we only use cryptocurrencies with at least four-years of price history (as per CoinGecko data). We compare the results against a buy-and-hold strategy for five cryptocurrencies (Table 2 and Table 3).

Bitcoin’s CAGR is similar for both strategies (around 42%), but the TOTM strategy has a maximum drawdown of 53% compared to 84% for the buy and hold strategy. Cardano also stands out. The TOTM delivered a 40% CAGR; the buy and hold strategy delivered a negative CAGR. Overall, TOTM saw consistently reduced maximum drawdowns, in comparison to buy and hold. SRs improved, too

With the caveat of a much smaller history of data, we conclude that the TOTM effect applies to cryptocurrencies. While history is not (necessarily) indicative of the future, the results for the S&P 500 have held up since the 1960s, while there have been other studies that have found similar findings for other assets.

Why Are Returns Higher at the Turn of the Month

The TOTM strategy is simple to implement, but the fundamental reason for its apparent effectiveness is not so obvious.

One idea is that it could be related to risk (as measured by the standard deviation of returns). Is risk higher during TOTM periods? If so, it could be explained by a risk premium being collected for holding the positions during those riskier periods. We investigated the risk profile of returns during the TOTM periods and the non-TOTM periods for the S&P 500 and the various cryptocurrencies and found that there was no significant difference. That is, there is no TOTM risk premium.

Other potential factors that may contribute to the effect include monthly rebalancing of portfolios, settlements of monthly transactions, alignment of fiscal calendars and the pay day effect (most employers get paid at the end of the month).

In any event, the strategy could be low hanging fruit for investors looking to get exposure to cryptocurrencies whilst also mitigating some of the drawdowns.

Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)