What is the September Effect? How to Trade it?

Did you know that Wall Street has a history of negative returns during September between 1925 and 2023? The only exception was 2024, when the S&P 500 surged nearly 114 points, and the DJIA gained 767 points. A common misconception is to start selling during underperforming cycles. However, recognising the factors that trigger the September Effect and adjusting your trading strategy accordingly could help you capture more stock trading opportunities during the month.

What is the September Effect?

The September Effect is a widely recognised seasonal phenomenon, when the stock market returns are lower than average, often negative. Unfortunately, due to the widely accepted perception that stocks will perform badly during the month, the bearish sentiment starts to set in as early as the last few days of August, and well into the first week of October. This is exactly what happened during 2024 as well; however, the Fed’s rate cut and the resilience of the US economy supported the stock market.

Here are some factors that trigger tend to the September Effect:

End-of-Summer Rebalancing

Investors are back from their summer vacation in September, and children are going back to school. This is the time investors may reassess their portfolios and rebalance for Q4 to take advantage of a seasonal surge in certain asset classes. This increases selling volume, weighing on stock prices.

Election-Led Selling Pressure

Usually, the election cycle in the US begins in September. If investors expect a shift of leadership, they may rebalance their holdings, or if the Senate tries to utilise the last few weeks to pass a bill, the market may remain volatile. These increase the selling pressure on certain stocks. Being the world’s largest economy, the sentiment in the US ripples across the globe.

Year-End Tax-Loss Selling

As the fiscal year closes on September 30, many investors review their portfolios and sell off investments that have lost value. By realising these losses, they can offset the taxes owed on profits made from other trades. This practice, known as tax-loss selling, often leads to concentrated selling of underperforming stocks. At the same time, some investors shift their money into bonds as a safer alternative during volatile stock market periods. Together, these moves can put additional downward pressure on already weak stocks.

Market Psychology

Since a large percentage of investors believe that September is going to be a time of losses, the September seasonality works as a self-fulfilling prophecy. Pre-emptive selling to prevent any losses exerts downward pressure on prices, which in turn feeds the bearish momentum, further adding fuel to the fire.

Trading During the September Effect

A study by JP Morgan between January 2002 and December 2021 pointed out that 70% of the best market days occurred within two weeks of the worst market days. What does this mean for traders? 

First, that the markets may keep presenting you with opportunities, even if the broader trend is downward. Second, staying on the sidelines may result in missing out on some opportunities, as they occur right in the middle of gloomy periods. Third, a well-planned trading strategy can beat prophecies if you do your analysis right. So, what should you do?

Navigating the September Effect

Note that the September Effect is not guaranteed. Keeping an eye on macro events and factors that influence your portfolio is key to making informed trading decisions. Here’s how you can trade during the September seasonality:

Explore Defensive Stocks

Defensive stocks, such as healthcare, consumer staples and utilities, remain relatively stable even during market downturns. Gaining exposure to these stocks and rotating out of high-growth sectors could help reduce the volatility in your portfolio. A common way to gain exposure to a broad spectrum of stocks is via index trading. Trading sector-based indices allows you to get the benefits of the trend across the sector.

Spread Your Risk

Diversifying your portfolio adequately spreads the risk, giving you peace of mind that even if the stock market moves against your speculation, your portfolio will remain protected. Hedging with instruments inversely or uncorrelated to your portfolio is key here. Explore the forex, crypto and commodities markets to diversify.

Stay Updated to Trade the News

September is the closing of Q3, and staying aware of Fed meetings, interest rate decisions and policy announcements may create opportunities in the financial markets. Staying updated can help you identify opportunities in time and respond with informed trading decisions.

Trading the September Effect via CFDs

Contracts for difference (CFDs) allow you to explore the opportunities in rising and falling markets. This means you can take advantage of market movements even if it is trending downward. Derivative instruments, such as CFDs, can be a tool to maximise the opportunities you explore. Plus, CFDs can be traded on margin. That means with leverage of 10:1, you can open a position worth $1,000 by investing only $100. The rest will be loaned by your broker. Before you rush into CFD trading, note that larger positions mean your profit and loss potential will also be high, magnified by leverage. So, remember to employ robust risk management techniques and use leverage wisely.

Once you have a well-rounded trading strategy to navigate the September Effect, it is best to try it out on a demo account. You can backtest it and even simulate inputs to account for the ongoing factors and then enter the live markets with confidence.  

To Sum Up

• September is perceived as the worst month for the stock markets.
• Portfolio rebalancing and market psychology play a role in the September Effect.
• Even an underperforming period can offer trading opportunities.
• A well-diversified portfolio is key to navigating market uncertainties.
• Exploring defensive stocks and index trading can help retain portfolio value.
• Traders can explore the opportunities created by news events during September.
• Trading CFDs allows you to explore opportunities in rising as well as falling markets.

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