News Analysis date published New: 
Friday, September 7, 2012 - 07:00
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Friday, September 7, 2012 - 15:51
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Friday, September 7, 2012 - 07:00

If History Repeats, These Two Trades Could be Winners

Friday, September 7, 2012 - 7:00am

It's often said that what is past is prologue, and that's usually true when it comes to financial markets. And when we look at past performance for the markets in September, we get a gloomy sense of prologue. That's because, historically, September is the worst-performing month of the year for stocks.

This year, there are more reasons than ever to expect a September sell-off. If the Fed disappoints on the stimulus front, and if a deal to bail out floundering European Union nations doesn't meet investor expectations, then look for this September to be much worse than its already sullen historical norm.

Looking Back at the September Slump

Before we get to today's trades, let's take a look at a few statistics, as they are telling.

Since the Dow Jones Industrial Average was founded in 1896, on average, the index has fallen 1.1% during September. During the 115 years of Septembers, the industrial average was in the red for 58% of those months. The worst September ever for the Dow was back in the Great Depression year of 1931, when the benchmark index plunged some 31%.

Of course, things haven't all been bad for the Dow. In 1916, it saw a September gain of 12%. More recently, the index has finished in the positive for the month in five of the last seven Septembers. Still, the relative underperformance of the Dow in September versus every other month is a trend investors cannot dismiss. This trend becomes even clearer when we take a look at how the Dow's average return in September compares with other months since 2000.

On average, the Dow has lost 2.11% in September, easily making it the worst month of the year for stocks. June was the second worst-performing month, with an average return of minus 1.75%. Compare this performance to the best-performing month so far this century, April. Here we have an average 2.29% gain during the month. That performance is followed closely by October, where the Dow had an average monthly return of 1.86% since 2000.

Now, there are many possible reasons why September sees more selling historically than other months. One explanation is that portfolio managers come back from their August vacations intent on cleaning up their portfolios in advance of the closing out of the third quarter. This seems like the most likely reason to me, but the actual cause of the September slump hasn't really been identified. In fact, I have yet to see a good academic study explaining the phenomenon.

Whatever the reasons for the downbeat September, the historical trend is indeed real, and as such, traders who suspect this September will follow in history's footsteps can profit with two exchange-traded funds (ETFs) designed to move higher when the Dow heads lower.

1. ProShares Short Dow 30 Fund (NYSE: DOG)

The ProShares Short Dow 30 Fund is the ETF of choice for those expecting a September slump. This fund moves the inverse of the Dow, so if the Dow falls 2%, DOG will rise by 2%.

As you can see from the chart here, DOG has traded well below its long-term, 200-day moving average for most of the year. Since late June, this inverse Dow fund also has traded below its 50-day moving average.

If we see the tide turn in the Dow, and stocks in the industrial average revert to their historic September norm, then DOG is likely to spike back above both the 50- and 200-day moving averages by the end of the month.

2. ProShares UltraShort Dow 30 (NYSE: DXD)

The ProShares UltraShort Dow 30 is another ETF pegged to the inverse performance of the Dow, but DXD employs leverage to achieve twice the inverse of the performance of the industrial average.

This is an ETF for traders who really believe that the Dow is headed for doom in September, and with DXD, that doom could translate into some very substantive gains if the September slump comes to fruition.

Action to Take --> Buy DOG at the market. Set initial stop-loss at $32.55. Set initial price target at $37 for a potential 5.5% gain by the end of September. Buy DXD at the market. Set initial stop-loss at $46.32. Set initial price target at $55.29 for a potential 11% gain by the end of September.

This article originally appeared on TradingAuthority.com:

If History Repeats, These Two Trades Should be Winners

Jim Woods does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.