Stocks: Sell in May and Go Away?

May 14, 2013— -- For decades, Wall Street has provided investors with a bit of supposed seasonal wisdom this time of year in the form of a rhyming slogan: "Sell in May and go away."

The saying actually originated in England, but many Wall Street traders have adopted it – and not just to free up summer days to spend in the Hamptons. To be fair, some studies have shown that, in many years, stocks haven't done as well between May and October as they have the rest of the year. Yet, over the past couple of decades, stocks in some sectors, including consumer staples and healthcare, have performed well during this time period.

Those who sell based on this slogan might be making an error that could cut into their investment returns. Strategically, they're definitely erring because it's never a good idea to sell or buy reflexively based on the calendar or any other arbitrary reason.

Moreover, selling based on the calendar is a perennial form of market timing: trying to predict market declines or upswings and time stock purchases or sales accordingly. Market timing is considered a risky practice because there's just no way to know what the market will do at any given point. By following the slogan and selling in May, investors are putting blind faith in their ability to time the market predictably every year based on nothing more substantial than a rhyme that assumes that conditions for a downturn will necessarily be in place.

Instead of following this slogan, investors should evaluate the fundamental and technical aspects of each stock in their portfolio before selling.

There are good reasons not to sell a given stock this month or any other May — or any other month. Here are a few:

• Money Flow. On any given day, if more shares are purchased amid an uptick trend than during a downtick, net money flow is positive. Over the past month of trading, determine whether there are more buyers than sellers amid above-average volume. If the bulls are in charge and big money is flowing into a stock on heavy volume as it's breaking out of its 50-day and 200-day moving averages, then it will likely continue to rise because price is a function of supply and demand. By the same token, if a stock dips below its 50- and 200-day moving averages on heavy volume, you should consider selling.

• A strong showing in terms of the relative strength index (RSI) — a measurement of strength, in terms of potential for continued upward momentum, relative to the overall market, according to various metrics. A stock with good RSI has far more upticks than downticks and increasing end-of-trading-day closing prices. Conversely, sustained decreasing RSI could provide the first clue that a stock should be sold. This alone is not necessarily a good reason to sell, but it's a better reason than the calendar.

• Rising institutional ownership. Popularity among institutional investors tends to mean purchases of large blocks, which can significantly boost prices and RSI.

• Rising earnings per share (EPS) figures. EPS is the most fundamental indicator of value because it shows in one number how much profit the company is making. By comparing the current quarter's EPS to the same period a year ago, an investor can see how the EPS are growing in similar conditions. Earnings, and especially earnings guidance, during the quarter, are some of the most important factors determining what a company – and its shares – are worth.