Month end trading is different to other trading days. All the big players are active on the last day of the month. Pension funds, commodity funds, hedge funds, mutual funds, you name it the big players are all there. They enter the market and buy and sell en masse.
There are so many big players present at month end that their aggregated behaviour can distort the price of a market more than normal. Their trading size is so large that they have been shown to create distortions in stock markets over the month end period. Month end effects are often attributed to just equity markets but almost all asset classes will have their own month end effects.
Window Dressing and Rebalancing
There are a number of reasons for month end effects but the main ones are window dressing and portfolio rebalancings.
Most traders have heard of month end window dressing. Window dressing is the practice of unloading some under performing markets in favour of markets that have been performing well. This is a common practice that fund managers do to make their portfolio look better to investors before they publish their positions.
Portfolio rebalancing involves buying or selling markets in a portfolio to maintain an original level of asset allocation. For example, 50% stocks and 50% bonds. It is very common for investors to only rebalance their portfolios once a month on the last day of the month.
The effect of window dressing and rebalancing is that there will be much greater volume and paper than normal going through the markets.
Great Trading Opportunities
Any time there is increased volume or paper going through a market then there will be opportunity to capitalise on it. Month end trading is no different and month end can present some fantastic trading opportunities. It can also present a lot more risk.
If you’re sufficiently prepared, if you’ve analysed the patterns and how to take advantage of them then trading month end can be one of the most profitable days of the month. But it all starts with the premise of treating month end differently to normal trading days and this means changing our trading plan for month end.
Particular attention should be paid to the close of the market or the run up to the close. This is where you’ll see a lot of volume take place. This can be a particularly busy part of the day and one that presents ample trading opportunities.
Change of Plan
In any scenario where there is a significant increase in volume then you can also expect market prices to go further than normal. This presents an increased level of risk. Any changes you make to your plan should be done with the aim of minimising risk. Different market conditions require a different trading plan to normal because the dynamics you see on normal trading days are often disrupted.
Given the increased risk, mean reversion strategies should be traded with some caution. I’ve seen mean reversion strategies get absolutely steamrolled on month end. The big players are ruthless and if they have business to do they will get it one regardless of the price they have to pay.
On the other hand, breakout or momentum strategies can provide some great winners. You can get disproportionally large winners from breakout trading on month end.
Whatever strategy you plan to trade month end you should always take a detailed account in your journal of what has happened in the past. Knowing what has happened in the past on month end can provide a significant source of edge.