Visualising Market Trends: A Statistical Approach to Market Sentiments

Gan Jing (Khai), Dealer | Contract For Differences (CFD)

Khai graduated from Monash University with a Bachelor’s degree majoring in Econometrics and Finance. His interest is in exploring the use of technology into trading. Khai builds algorithms and test trading ideas for trading robots as he believes full automation is the future of finance.

As the saying goes “ Sell in May and Go Away” [1]. The saying warns investors that the market usually underperforms from May to October. Moreover, the market’s performance in December generally tends to do well due to factors such as window dressing [2] and the pre-Christmas effect [3]. It can also be observed that during the Chinese New Year, that is usually celebrated within the months of January to February, Asian markets often perform slightly better, though with lower liquidity [4].

On 5 Aug 2024, stock markets around the world experienced a tank in prices (in accordance to the saying) but then recovered and rose in the following days, which contradicted the expectation. This highlights the importance of investors understanding market trends and implementing strategies to counter current and near future market conditions.

This article will explore the 5 largest stock markets in South East Asia (SEA) – Indonesia, Singapore, Thailand, Malaysia and the Philippines.

Data Source: TradingView.com

Referring to figure (1), there are several periods when stock markets tend to move in the same direction, notably the Asian bull run in 1993; the Asian Financial Crisis in 1997 ; the Global Financial Crisis in 2007-2008, and most recently, the COVID Pandemic from  2020 to 2023.

We can also assess the correlation between stock markets by measuring the closeness of their returns during these times. This approach helps investors to understand how markets respond similarly or differently during major events. [a].

(Based on figure(2) above, the monthly returns among the SEA stock markets are moderately correlated (~0.5 to ~0.6); which means that SEA stock markets tend to move in the same direction. This likely suggests that the movement of one market can potentially spillover to the other markets.

The returns could be grouped monthly to better illustrate how these patterns align with the market trends described in  the quote:

With reference to figure (3), the monthly average returns data shows that the stock markets generally underperform in May and June, then recover slightly in July only to weaken further in August and September. The period from October to November shows some recovery. The Christmas (December) and Chinese New Year (January/ February) effects can also be observed with a higher average return in their respective months.

(4) The percentage of positive returns by month shows the proportion of index’s monthly returns greater than 0 for a particular month, i.e., among all the Januarys from 1992 to 2024, 62.50% of the Januarys have a positive return. The similar effect can still be observed from May to October as well as the Christmas and Chinese New Year effect from December to January/ February.

Remarkably, the data also shows that March is a down month and April is an up month.

Based on insights from the data, we can explore the hedging and speculative effects of CFDs [b]. The expectation is that the stock market index will deliver positive returns from October to February, and negative returns from March to September. The experiment below compares the return and drawdown of a portfolio when an investor hedges or speculates during these months.

Portfolio A – Buy and Hold 1 STI SGD5 CFD (Buy & Hold)

Portfolio B – Buy and Hold 1 STI SGD5 CFD between October and February (Hedging)

Portfolio C – Buy and Hold 1 STI SGD5 CFD between October to February; Sell and Hold 1 STI SGD5 CFD between March and September (Speculative)

The hedging strategy involves fully hedging between March and September, assuming poor stock market performance during this period. The speculative strategy, however, takes a short position on the stock market index between March to September, aiming to capture potential profits from the anticipated market downturn. The experiment is conducted on the STI and KLCI indices respectively.

Portfolio D – Buy and Hold 1 KL Index MYR10 CFD (Buy & Hold)

Portfolio E – Buy and Hold 1 KL Index MYR10 CFD between October and February (Hedging)

Portfolio F – Buy and Hold 1 KL Index MYR10 CFD between October and February; Sell and Hold 1 KL Index MYR10 CFD between March and September (Speculative)

There are several metrics that can be used to measure the performance of a portfolio other than profit. Measuring the drawdown of the portfolio is also useful for evaluating the risk associated with the portfolio’s strategy. For a simple buy-and-hold strategy, drawdown would always be zero as long as the index remains profitable. However, when tracking unrealised profits in a buy-and-hold approach, you may notice equity fluctuations. If the equity reaches a new high and then declines, there is an implied “loss” in equity because you could have taken profit at a higher equity level. Thus, to account for this “loss”, we record the highest equity achieved and measure any subsequent fall from that peak as a drawdown—known as high equity drawdown.

(5) The STI index portfolio results show that returns from the speculative portfolio yielded the highest returns, followed by the  hedging and  buy-and-hold portfolios. During the 2008 financial crisis, the speculative portfolio experienced a significant loss in profit, lowering its returns below the hedging portfolio. Notably, from 2008 to 2024,  the index was ranging between 3000 to 3500, yet both the hedging and speculative portfolios continued to generate profits. In contrast, the buy-and-hold strategy would have struggled to recover from high equity losses during this ranging period. Both hedging and speculative portfolios also have a lower high equity drawdown than  buy-and-hold portfolios.

(6) The KLCI index portfolio results show that profit from speculative portfolios is the highest followed by hedging and the buy-and-hold portfolios. The impact of market sentiment was more pronounced in the KLCI than in the STI, as the speculative portfolio outperformed the hedging portfolio during the 2008 financial crisis.  Since 2015, the buy-and-hold strategy would have reached a peak in high equity but struggled to recover thereafter. However, the hedging and speculative portfolios continued to yield profits even as the index declined. Once again, both hedging and speculative portfolios displayed a lower high equity drawdown than buy-and-hold portfolios.

Pricing in the financial market is a complex process, influenced by numerous observable and unknown factors! This example demonstrates only basic market behaviour, providing investors with insights for planning ahead. Risk averse investors may choose to hedge for risk management while more aggressive investors may consider to go short as a trading strategy.

[a] Using returns helps avoid secular trends and spurious regressions, with returns assumed to be stationary for this study.

[b] This experimental portfolio reflects only the CFD Index’s closing/opening price movements, precisely mirroring the underlying stock market index, and excludes transaction costs, swaps, dividends, financing costs, and CFD-spot price convergence.

[c] Details of Portfolio Results:

Portfolio A (Buy-and-Hold) – Profit is only realised at the end of the data. The index trends higher at the end of the data period but the portfolio experiences a high equity drawdown during 2008. Notably, post-2008 periods show continued drawdowns, as the index did not return to pre-2008 peak levels.

Portfolio B (Hedging) – Profit is realised at the end of every February. Positive returns from October to February outweigh the negative returns, resulting in overall growth

Portfolio C (Speculative) – Profit is realised at the end of every February and October. Shorting the index from March to October increases the returns of the portfolio by capitalising on market declines. The effect of the stock market crash in 2008 is also slightly mitigated as there was some profits gained from the short positions.

Portfolio D (Buy-and-Hold) – Profit is only realised at the end of the data. The index trends higher at the end of the data period but the portfolio experiences an increasing high equity drawdown post-2018.

Portfolio E (Hedging) – Profit is realised at the end of each February. Similar to Portfolio B, positive returns from October to February have a stronger effect than the negative returns, leading to overall growth.

Portfolio F (Speculative) – Profit is realised at the end of February and October. Shorting from March to October significantly boosts returns by leveraging the index’s decline. From 1996 to 2004, the market followed the statement closely, resulting in substantial realised profits.

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References:

[1] https://www.investopedia.com/terms/s/sell-in-may-and-go-away.asp#:~:text=%22Sell%20in%20May%20and%20go%20away%22%20is%20an%20adage%20referring,6.3%25%20from%20November%20to%20April.

[2] https://www.nasdaq.com/glossary/w/window-dressing

[3] https://www.cnbc.com/2018/12/21/the-santa-claus-rally–no-ho-ho-ho–.html

[4] https://www.phillipcfd.com/traders-must-know-chinese-new-year-effects/

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