The start of each trading year is usually tricky for market participants as they leave behind the festive period. The hype about the new year is not enough to keep the spirit high, but there is an unofficial market rule that makes the first few market sessions purposeful. The famous “five-day” rule states that the yearly performance of the US 500 cash index would be positive if the return on the first five trading days of the year is positive. There have been a few studies on this rule and certain famous investors appear to adopt it in their overall strategy. However, there seems not to be sufficient fundamental or technical justification for this rule. Does it really hold, or do market participants just enjoy endorsing myths that point to a bright future?
We have analysed this rule for six securities: US 500 cash index, GER 40 cash index, EURUSD, GBPUSD, Gold and WTI oil futures. We used daily data since 1992, with a total of 31 trading years examined.
Equities and commodities appear to follow the rule; currency markets ignore it
The rule was made exclusively for the US 500 index, and our findings offer some confirmation. There is a 76% success rate, meaning that in roughly 3 out of 4 years that the index had a positive run in the first five days, it ended the year with a positive return. And the average return in these successful years is an acceptable 21%, as seen in Table 1 below.
The rule appears to be valid for the GER 40 cash index as well, with slightly improved results. A 78% success rate is uncommon when examining historical patterns in financial securities’ performance. Hence the rule seems to hold for equity markets. Like the US 500 index, the average yearly performance of GER 40 on successful years is a sizable 23%.
Overall, in our sample, regardless of the initial five-days performance, the US 500 index has recorded 22 years with positive return with an average return of 18%. Similarly, the GER 40 index has also seen 22 positive years with an average annual return of 22%.
On the other hand, our findings for the currency markets are not optimistic. The EURUSD and GBPUSD pairs show a 40-50% success rate. Therefore, the rule seems not to extend to mean-reverting instruments.
The results of gold and WTI oil futures hold a surprise. Their respective 69% and 70% success rates are not negligible considering the unique nature of the commodities space. The average performance on years that the “five-day rule” holds is significant, especially for gold, where an impressive 16% return has been recorded.
Maybe the rule holds in reverse? A negative five-day performance points to a negative yearly return?
The simple answer is no. The results for the equity and commodities markets are very weak. However, there seems to be some connection regarding the two FX pairs we examined, EURUSD and GBPUSD. In both cases, there is a decent 60% success rate, meaning that if the performance is negative in the first five-days of the year, the year-end performance would be negative.
Technical analysis matters too – Gold especially interesting at this juncture
From a long-term perspective, using the weekly chart, gold has been on a downward sloping trend since March 2022. But there is increasing evidence that could worry the bears. The recent jump higher and the convergence of the 50- and 100-day simple moving averages (SMA) have brought the bearish trend into question, especially as the stochastic oscillator is hovering above its overbought territory.
