Trading the holiday effect

The holiday effect is a well-known market phenomenon: a liquidity vacuum creates the possibility of large moves in price. A strong move into a holiday tends to continue, but it can just as easily reverse once participation returns to normal. Volatility can also be greatly exaggerated at these times, and some research has shown returns many times those of normal days.

Human behaviour plays a big part in how the market environment changes. Desks close early, traders are away, trades are closed to limit risk into the holiday, and investors are generally in a boisterous mood, full of optimism about the future and keen to express it as a trading position.

Let's look at some of these features.

Here are some characteristics of the holiday effect.

• The data docket may be light or empty, and data may be delayed over the holidays.
• Strong moves into the holidays tend to carry over into the holiday.
• Larger participants tend to be less active.
• Buyers and sellers chasing fills struggle to find the liquidity they need to execute orders efficiently.
• Lower volume means the market will generally trade at a slower pace.
• The liquidity vacuum also means price can move freely away from value before quickly reverting once participation is restored.
• Important new information that needs to be repriced can create extreme volatility.
• Markets are busier, closer to normal, in the EU and Asia sessions, and volume dies down past lunchtime.

So it's not as simple as it looks. No!

It would not be prudent to go long every holiday, even leaving out those that fall in February, May, June and September, but there may be something here to watch for.

It's possible the effect is only an amplification of monthly and seasonal effects, caused by lower liquidity. Post-holiday reversals are real and happen quite often: like any weak auction, the holiday move is open to correction. Watch closely for signs of continuation once full participation is back.

Here are my top tips for traders who want to trade over this period.

• Large participants may be absent during these periods, and with liquidity limited, moves may be exaggerated. Momentum traders may find these conditions favourable, with tight risk.
• Keep your trading discipline. HTF levels should be respected as larger participants skip the session. On smaller time frames, participants tend to look for obvious anchors and prior reference points. This is actually a sign of weakness, and weaker reference points have a habit of being revisited and broken. If key reference points are not being respected, that should be a major alert.
• Be mindful of poor structure created as price and value separate in thin liquidity. Look to trade value, not price, especially once participants return.
• Stops can set off a cascade of other automated stops and cause a sudden crash, so be careful trading near key areas where stops may be lurking.
• Don't chase trades; let them come to you. This is an important rule of trading, and it's never more important than on days when liquidity is thin.
• Be alert to new information: it can create a very volatile trading environment.
• Watch other markets, where participation is more regular, for clues.
• Step away and enjoy the holiday.

In a follow-up to this post I'd like to keep writing about market seasonality and its effect on price. I'll explain how I use Python and Prophet to analyse these effects, and how I use the information to strengthen my understanding and conviction.

You can follow me trading live on YouTube. Until then, trade well and prosper. BT.