How You Can Profit While Wall Street's 'On Vacation'

Getty Images

"Sell in May and go away" is more than just a catchy Wall Street adage. Somewhat surprisingly, it seems to actually be how Wall Street does business. Trading volume generally peaks in May, then tapers off over the summer, only to start climbing back in September.

There are various theories for this slowdown in volume, ranging from summer vacations to the IRA contribution laws that let people put their money in for the prior year up until mid-April. Whatever the reason, lower trading volumes often bring with them higher volatility -- as we've seen with recent market swings -- and in those swings may very well be your opportunity to profit.

What's Wall Street Doing?

It's really quite astounding just how consistently volume tapers off. The chart below, covering the last 10 years of S&P 500 (^GSPC) volume, shows just how profound a slowdown there is over the summer:

Wall Street Chart
Data from Yahoo! Finance

When Wall Street isn't paying as close attention to what's going on, the ride can get wild. After all, the stock market is made up of willing buyers and sellers. The more participants there are in that market, the greater the chances that there'll be a willing buyer for any given seller and a willing seller for any given buyer.

When trading volume drops as people (or these days, their algorithms) stop paying close attention, it gets tougher to match up buyers and sellers. That can result in higher volatility.

What You Can Do About It

At its core, all higher volatility means is that prices whip around more. That whipsaw can be painful for investors who check their portfolio balances on a daily basis -- but it can provide an awesome opportunity for value-focused investors who are looking to buy low and sell high.

Sponsored Links The more a stock's price oscillates, after all, the less likely it'll reflect what the company behind that stock is truly worth. And the farther away from that true value a stock is trading, the easier it is for a value investor to buy (if it's trading too cheaply) or to sell (if it's trading too expensively).

The tough part is figuring out what a company's true value is, as that more or less requires you to be able to predict the future. In reality, nobody predicts the future perfectly correctly. Even a company itself doesn't know exactly what it'll deliver.

For instance, United Parcel Service (UPS) recently lowered its earnings outlook as customers shifted to lower-cost shipping options. And UPS is not alone in having that difficulty predicting the future. Earlier this year, Walmart (WMT) also guided expectations down, showing that even the world's largest retailer can't always get it right.

If You Can't Get It Right, Guess Low

Because nobody gets it perfectly right, as a value investor, you're better served by figuring out your best estimate for what the company is worth by being a bit conservative in your assumptions for its future. Then, on top of that, build in an additional fudge factor below that estimate and only be willing to buy the company's stock if it trades below that discounted level.

Indeed, it's that fudge factor that forms the foundation of the value investing strategy.

Master value investor Benjamin Graham named that fudge factor the Margin of Safety, which he called the secret of sound investing. Generations of successful value investors have made their fortunes waiting to buy companies trading far enough below their estimates of fair value so that they carry decent margins of safety.

As simple as that sounds, it can be tough to do in practice.

When the market is rising, people have a tendency to want to buy in order to get in for fear their stocks will "get away" from them. On the flip side, when the market is falling, people often become afraid to buy, on worries that stocks will continue to fall.

When you, as a value investor, look at a stock's price in terms of what the company behind it is really worth, and commit to only buy with a margin of safety, you can turn that fear and greed on its head.

Embrace Summertime Opportunity

Remember, when Wall Street is on vacation, if the market gets more volatile as fewer people are taking part in it, learn to view that volatility as an opportunity to find those bargains.

If you do, you may one day find yourself among the pantheon of value investors who've learned to profit by waiting for volatility-induced bargains and then buying great companies at discount prices.

An Iron Throne for Your Golden Years: Our 'Game of Thrones' Stock Picks
See Gallery
How You Can Profit While Wall Street's 'On Vacation'
Stock: Goldman Sachs (GS)
As the Master of Coin on the Small Council in King's Landing, Petyr is in control of the kingdom's finances. And while the ruling Lannister family has a wealth of gold, the kingdom's expenses are many. So it's no surprise that Petyr would prefer investing in a large investment banking and securities company such as Goldman Sachs. Not only does Goldman Sachs profit from various financial services, but the company seems to always be profitable regardless of what happens in the stock market, housing market, or broader economy.
Stock: Zynga (ZNGA)
Even a child ruling a kingdom needs to blow off steam once in a while. That makes Zynga, a company focused on building social and casual games, the perfect pick for Joffrey Baratheon. Zynga also watched many of its executives leave the company and its stock price plummet, similar to the situation that Joffrey faces in King's Landing as the kingdom unravels. Yet Zynga's stock structure provides its CEO, Mark Pincus, 70 votes per share. That means that as of the end of 2012, Zynga's CEO owned 59 percent of the total voting power. Take that, mere commoner! It's not bad to be the head of Zynga... unless your stock's awful performance costs you a spot on the Forbes billionaire list.
Stock: Yahoo! (YHOO)
The Queen Regent and mother of Joffrey Baratheon, Cersei Lannister would admire a bold female CEO such as Marissa Mayer of Yahoo! Joining Yahoo! less than a year ago, Mayer is determined to turn around the struggling company, and is focused on building Yahoo!'s employees and changing the internal culture. Bold leadership is something that Cersei would identify with, although the two have quite different perspectives on how to get results.
Stock: LinkedIn (LNKD)
Tyrion Lannister is often underestimated by those around him given his size and appearance. But time and again his intellect is what wins the day. Tyrion understands the value of building an intelligence network throughout King's Landing, which is why he would invest in LinkedIn. In the social media realm, LinkedIn is also oftentimes overlooked due to Facebook's much larger user base -- over 1 billion monthly active users, compared to its own roughly 200 million total registered users (not monthly active users). Although Facebook towers over LinkedIn, LinkedIn's revenue per user was 20 times that of Facebook as of this summer.
Stock: Apple (AAPL)
Having lost his father, Eddard Stark, Robb is trying to lead his father's men to the best of his ability. While he lacks experience on the battlefield, his father taught him many lessons in leadership and duty. That's why Apple would catch Robb's interest as an investor. When Tim Cook became CEO of Apple, outsiders wondered whether he was capable of leading the giant tech company. While the company has had its challenges since then (e.g., Apple Maps), its position as one of the most influential tech companies has not been usurped by any of its rivals.
Stock: Caterpillar (CAT)
As a steward of the Night's Watch, Jon Snow must protect the Wall. He knows that winter is coming -- and the Wall might need some fortification. That would make Caterpillar, which focuses on construction and building infrastructure, top on his investing list. Since some of Caterpillar's products are used for snow removal, Jon Snow would also be demonstrating a Peter Lynch mentality of buying what you know.
Stock: Garmin (GRMN)
Living in exile hasn't been easy for Daenerys, as she's never found a true place to call her own. But as she establishes her identity as the Mother of Dragons, she's determined to return to Westeros. As someone seeking direction and a way home, Daenerys would likely buy shares of Garmin for her investing portfolio. The GPS technology company creates navigation products for every mode of transportation, including air and sea. And if she's ever to return to Westeros, one of Garmin's marine products would sure be useful.
Stock: Berkshire Hathaway (BRK-A; BRK-B)
As a eunuch, Varys demonstrates his power through a (spider)web of contacts that feed him information. He uses information to gain a personal advantage, creating an insurance policy of sorts. Therefore Varys would be a fan of the insurance model and invest in Berkshire Hathaway. Berkshire Hathaway is a large conglomerate holding company, owning stakes in or even whole companies across many different industries. Similarly, beyond his network of information-sharing contacts, Varys seems to have a hand in structuring deals or alliances across the kingdom.

Motley Fool contributor Chuck Saletta owns shares of United Parcel Service. The Motley Fool recommends United Parcel Service. Try any of our newsletter services free for 30 days.

Read Full Story