Dow Signal Suggests Stock Traders Shouldn't 'Sell in May' This Year

The Dow Jones Industrial Average (DJIA) wrapped up the holiday-shortened week by closing beneath its lower Bollinger Band -- often interpreted as an "oversold" indicator -- to mark its lowest finish since mid-February. It was the first time the index breached its lower Bollinger Band since March, as stocks sold off and the CBOE Volatility Index (VIX) spiked amid geopolitical concerns. Historically, these signals have marked prime buying opportunities for blue-chip stocks, preceding the post-Brexit rally, the so-called Trump Rally, and the Dow's rally to record highs in the first quarter of 2017. If past is prologue, DJIA traders may not want to "Sell in May and go away."

Recent Signals Preceded Massive Rallies for the Dow

Going back to 2010, there have been 35 of these signals -- characterized as the first breach of a lower Bollinger Band in at least 10 days -- according to data from Schaeffer's Senior Quantitative Analyst Rocky White. The last signal sounded on March 21, and while the Dow has crept just modestly higher since then, other recent signals led to massive rallies for the index over the next three months.

Below are the last 20 signals. After the pre-Brexit breach of its lower Bollinger Band on June 24, the Dow went on to add nearly 6.2% in the subsequent month. After the early September signal, the Dow was also notably higher in the short term, and the pre-election signal on Nov. 2 preceded a three-month rally of almost 11.8%. The first signal of 2017, in mid-January, sent the Dow 4.5% higher over the next month, culminating in a record high of 21,169.11 on March 1.

History Suggests Dow Could Rally Again Into May

Of course, one could argue that recent signals were the result of macro uncertainty, and the subsequent price action was made up of "relief rallies." However, looking at the data since 2010 seems to confirm our theory of short-term gains for the Dow after such breaches of its lower Bollinger Band, with more volatility than usual, as indicated by "Standard Deviation" in the chart below. 

Going out one week after a signal, the DJIA has added 0.39%, on average -- roughly double its anytime one-week return since 2010. Likewise, the Dow has averaged a healthier-than-usual gain of 0.68% two weeks after a signal, compared to an average anytime gain of 0.4% during this time frame over the past seven years. Looking one month out, the Dow has averaged a 1.41% gain after these signals, compared to a one-month anytime gain of 0.86%. The "Percent Positive" in the chart below further reflects this.

Looking three months out, however, things start to even out. The Dow averages a post-signal gain of 2.89% -- slightly better than its average three-month return of 2.56% -- but is higher just 69.7% of the time, compared to 71.3% normally.

As alluded to earlier, if recent history is any indicator, traders may want to reconsider the old "Sell in May and go away" theory. Not only because recent breaks of the Dow's lower Bollinger Band have screamed buying opportunities, but because the month of May has been second to only July for stocks during the first year of a presidential cycle, as founder and CEO Bernie Schaeffer pointed out earlier this year. What's more, uncertainty surrounding the French elections and escalating tensions between the U.S. and North Korea, not to mention lackluster first-quarter earnings from a few Dow stocks this week, could clear a path for yet another relief rally for the index.