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October 27 2009| Filed Under Currencies, Economics, Economy, Financial Crisis, Financial Theory, Forex, Forex-Beginner, Recession
October is a unique month. In the west, October is a transitional month, autumn sliding relentlessly towards winter. It also boasts the only holiday where people are encouraged to dress up, scare each other and extort candy with threats of mischief. October has a special place in finance, known as the October effect, and is one of the most feared months in the financial calendar. In this article we'll look at whether there's any merit behind this fear.
The events that have given October a bad name span 80 years. They are:
The Panic of 1907 (October 1907)
A financial panic threatened to engulf Wall Street, mostly owing to threats of legislative action against trusts and shrinking credit. There were multiple bank runs and heavy panic selling at the stock exchange. All that stood between the U.S. and a serious crash was a J.P. Morgan led consortium that did the work of the Fed before the Fed existed.
Black Tuesday, Thursday and Monday (October 1929)
The Crash of 1929 was bloodletting on an unprecedented scale because so many more people were involved in the market. It left several "black" days in the history books, each with their own record breaking slides. (For more, see The Crash Of 1929 Could It Happen Again?)
Black Monday (October 1987)
Nothing says Monday like a financial meltdown. In 1987, automatic stop-loss orders and financial contagion gave the market a thorough throttling as a domino effect echoed across the world. The Fed and other central banks intervened and the Dow recovered from the 22% drop quite rapidly. (See What Is Black Monday? for more.)
Taking the Blame for September
Oddly enough, September, not October, has more historical down markets. More importantly, the catalysts that set off both the 1929 crash and the 1907 panic happened in September or earlier and the reaction was simply delayed. In 1907, the panic nearly occurred in March and, with the tension building over the fate of trusts, could have happened in almost any month. The 1929 Crash arguably began when the Fed banned margin-trading loans in February and cranked up interest rates.
September has its share of "Black Days," too:
Black Friday
The original "Black Day," Black Friday (1869), was in September. Jay Gould and other speculators tried to corner the gold market, working with an insider at the Treasury. The price kept rising until the Treasury broke the corner by selling $5 million in gold, dropping the price of gold by $25 in a single day and ruining many speculators.
Black Wednesday
Black Wednesday, Soros' raid on the British pound, is another September event considered infamous by people outside of the forex community (within the forex community, it's revered as of one of the greatest trades ever made). Soros made a billion on the deal, but the British government lost billions trying to shore up their currency leading up to the eventual capitulation. (To learn more, see How Did George Soros "Break The Bank Of England"?)
Black Swans
September 2001 and 2008 single day point declines in the Dow were bigger than Black Monday 1987, the former owing to the attacks on the World Trade Center and the latter to the subprime mortgage meltdown. The 2008 September plunge went far beyond the U.S. economy, trimming almost $2 trillion from the global economy in a day. (For more, see our Investopedia Special Feature: Subprime Mortgages.)
Taken as a whole, a very strong argument can be made for September being worse for the markets than October.
An Angel in Disguise?
Surprisingly, October has historically heralded the end of more bear markets than the beginning. The fact that it is viewed negatively may actually make it one of the better buying opportunities for contrarians. Slides in 1987, 1990, 2001 and 2002 turned around in October and began long-term rallies. In particular, Black Monday 1987 was one of the great buying opportunities of the last 50 years. Peter Lynch, among others, took this opportunity to load up on solid companies that he'd missed on their way up. When the market recovered, many of these stocks shot up to their previous valuations and a select few went far beyond. (Read more in, Pick Stocks Like Peter Lynch.)
Conclusion: October Effect Unjustified
October gets a bad rap in finance, primarily because so many black days fall in this month. This a psychological effect rather than anything to blame on October. The majority of investors have lived through more bad Septembers than Octobers, but the real point is that financial events don't cluster at any given point. The worst events of the 2008/2009 financial meltdown happened in the spring with Lehman's collapse, more stocks fall in November and December due to year-end rebalancing, and many financially damaging events haven't been given Black Day status simply because the media didn't choose to dust off that moniker at the time.
Although it'd be nice to have financial panics and crashes restrict themselves to one particular month, October is no more prone to bad times than the other 11 months in the calendar. (For more, see our Market Crashes Tutorial.)
by Andrew Beattie
Andrew Beattie has spent most of his career writing, editing and managing Web content in all its many forms. He is especially interested in the future of search and the application of analytics to the business world. In addition to being a long-time contributor to Investopedia.com, Andrew has been working on ForexDictionary.com.