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How to Trade the Midterm Elections

2. Wait for the Post-Election Surge

Midterm election years tend to be more uncertain than presidential election years. During presidential election years, the focus tends to be on the presidential race, whereas while congressional races are important, they tend to be of a secondary nature to the media and electorate. Furthermore, the presidential candidate tends to have "coattails" upon which the congressional candidates will ride.

Without a presidential race in the midterm election year, the outcome of the congressional elections is less certain. Thus, the markets tend to be subdued in advance of the election and react positively after the election.

This is quite evident from the data that I have presented above. While you might want to sell in May and remain out of the market until October, once the election takes place, you might want to get aggressively get long the market at the end of September. The fourth quarter of the midterm election year and the immediately following quarter -- the first quarter of the pre-presidential election year -- are the two best quarters in the 16 presidential election cycles. These two quarters have yielded positive returns in 14 of the 15 cycles in which they have occurred. The one losing outcome was fourth-quarter 1978/first-quarter 1979, which declined only by approximately 50 basis points.

3. A Slow January, Then a Bounce

January in a midterm election year is also a losing month, January has been no exception. However, during midterm election years, February and March have been strongly positive years. So after a month of profit-taking in January, you may want to put money back to work for the next two months.

In 10 of the 15 midterm election years, the SPX has advanced during the February to March time period. Those years in which the February to March period declined in a midterm election year were: 1966 (-3.93%); 1974 (-2.68%); 1978 (-0.04%); 1982 (-7.01%); 1994 (-7.44%)

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