Fosback Seasonality Strategy

09Mar10

This is a test of Norman Fosback’s seasonality strategy as described by Mark Hulbert.

See Hulbert’s piece for the whole story, but two important points to note are (a) this strategy began trading in the mid-1970’s (meaning there’s a huge amount of out-of-sample data), and (b) the strategy was ranked #1 at HFD for 20-year risk-adjusted return at the time of its passing.


[logarithmically-scaled, growth of $10,000]

The graph above shows the S&P 500 index (grey) versus Fosback’s strategy (red) trading the S&P 500 from 1950 (strategy rules to follow).

Geek notes: (a) these results do not account for transaction costs, but could be closely reproduced in today’s market using mutual funds (less part of an annual expense ratio), and (b) because a benefit of this strategy is so much time spent in cash, I’ve included a return on cash of half the nearest 13-week UST.

Numbers for the number lovers…

Fosback’s strategy rules:

1. “To exploit positive seasonality around the turns of each month: Buy at the close of the third-to-last trading of each month, and sell at the close of the fifth trading session of the following month.”

2. “To exploit positive pre-holiday seasonality: Buy at the close of the third-to-last trading day prior to exchange holidays, and sell at the close of the last trading day before a holiday.”

3. “Exceptions: If the holiday falls on a Thursday, sell at Friday’s close rather than Wednesday’s. Also, if the last day before a holiday is the first trading day of the week, don’t sell until the day after the holiday. Finally, never sell on the first trading day after options expire; instead wait an extra day.”

Note that the first play is very similar to the Turn of the Month strategy we’ve shared in the past.

Thoughts

The strength of Fosback’s strategy hasn’t been so much in producing gains as drastically reducing volatility and time invested in the market (both of which are inherently good things).

Two things in particular I don’t like about the strategy. First, like most seasonality strategies, it has gone through long periods significantly underperforming the market, especially during bull trends. And second, it suffered its worst failures very recently as the chart below of performance since 2000 shows.


[logarithmically-scaled, growth of $10,000]

The strategy has outperformed the market over the last decade, but clearly has not been its low-volatility/drawdown self.

Though the strategy hasn’t been as effective as others we’ve tested on the blog, I think the fact that it has traded so successfully for so long out-of-sample earns it a bit more consideration. I’ll likely be adding it as another strategy on the Addendum.

In a follow up post, I’ll break out the two parts of the strategy, holidays and the turn of the month, in separate tests.

[Edit: click for a summary of posts related to Fosback Seasonality] 

Happy Trading,
ms

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11 Responses to “Fosback Seasonality Strategy”

  1. 1 eber terandst

    Yes, adding it to the Addendum would be a very valuable thing. The Fosback strategy, which is in circulation under many different names ( e.g. Ride the Wave in The Motley Fool) is very intriguing: why seasonality would work at all ? So, having it displayed on a regular basis will make for very interesting observations.
    Thanks for this very nice post.
    eber

    • 2 MarketSci

      RE to eber: hello sir. Do you have a TMF link to the Ride the Wave? A quick google search sent me to a forum but I didn’t see one post that explained the strategy. Would like to test any variation from Fosback’s rules above. thanks, michael

  2. 3 tb

    Do you include returns from the cash while computing volatility? If yes I do not think this is a good idea. You obviously have two regimes of volatility: one when the strategy is invested in risky assets and one when it is not. Calculating a volatility including both regimes would be like calculating an average temperature between North Pole and Cairo… in the middle you are perfectly fine…

    • 4 MarketSci

      RE to tb: I disagree wholeheartedly. This is a portfolio-level view of the strategy, not a per-trade view. I’ve annualized volatility (based on monthly returns) to show the general month-to-month vol an investor would have suffered. The fact that on any given day the strategy might have bore full market risk is inherently obvious based on the nature of the strategy. michael

      • 5 tb

        I strongly disagree with your “portfolio view”. You miss some risk management practical view here. Just imagine a strategy invested only one particular week per year and otherwise invested in cash. Would you leverage it 7 times just because it is supposedly 7 times less volatile?

        In your analysis you are mixing two different risks: the risk of equity investment and the risk of cash investment. You then ‘agglomerate’ these two in a unique risk measure which is pure nonsense. When your portfolio is invested in equities it has a risk which is around the same as any buy&hold equity investment. When it is all in cash, your risk is very different (especially if you invested that in a money market fund…).

        Would you say you are fine being only invested during the week 15/09/08-19/09/08 in 2008 or 10/09/01-14/09/01 in 2001… with a leverage of 7?

        Conclusion is obvious: this strategy bears pure market risk and its risk should be reported as such… especially when directly compared to buy&hold risk!

    • 6 MarketSci

      RE to tb: I began to type a response to this nonsensical comment, but realized it’s a waste my time.

      A search of other comments you’ve posted on this blog shows a clear pattern of aggressive and thoroughly intellectually-challenged “critiques”.

      If you want to contribute to the ongoing discussion we’re attempting to have then I say BRAVO. If you’re going to just be a snarky little prick about every little tree you disagree with and completely ignore the forest we’re building here, then I kindly and respectfully ask that you not let the door hit you on the way out.

      michael

  3. 7 MK

    I think the poor absolute returns of the last decade are due to the poor absolute returns of the market as a whole – note that returns relative to the market are still good in the 2000s. This one should do better if combined with other indicators, like a moving average crossover.

  4. 8 eber terandst

    Mike: sorry, my mistake. Riding the Wave is just a momemtum type rotation system. I cannot find a reference now to the one I had in mind. I will post if and when I can find it. Meanwhile, apologies again for the confusion.
    Eber

    • 9 MarketSci

      RE to Eber: no problemo. I’d definitely be interested in seeing it though if you’re able to fish it out. thanks, michael

  5. 10 Highgamma

    I first read about these strategies in “Time In, Time Out: Outsmart the Market Using Calendar Investment Strategies” which was published in 2000. Made no reference to Fosback from my recollection. Just thought that you’d like to know.


  1. 1 Tuesday links: setups abound Abnormal Returns

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