January Effect

DEFINITION of the January Effect

The January effect is a calendar anomaly connected with the stocks with small market capitalization. It refers to a pattern in which stocks showed a tendency to rise during the last several trading days in December. And, they continued to rally throughout the first week of January.

WHAT IT IS IN ESSENCE

This hypothesis is built on the idea that markets are non-effective and because of that they experience seasonal anomalies. If markets are efficient, meaning based on the real price of an asset, the January effect would not exist.

The investor Sidney Achtel was the first who noticed this calendar anomaly. In fact, he saw that small-cap stocks had outperformed the wider market most January’s since 1925. Since this finding, there was a universal opinion that the shares of smaller companies would outperform other months in January, especially in the middle of the month.

The January effect is a theory based on a pattern that analysts have seen year after year. Put simply, stocks seem to fare better during January than they do during other months of the year. Generally, small-cap companies are affected, as large ones are typically less volatile.

Generally, there are some patterns in the markets, based on the sort of stocks you buy. For example, if you buy stocks that have leap up in value in relative and absolute terms over the past year, you can expect them to continue to rise. This is momentum.

Some say the January effect is fading, while others say it isn’t real, to begin with. Goldman Sachs (NYSE: GS) says its analysis over the last 19 years shows that returns have diminished in the month of January compared to historical figures going back to 1974.

Some claim that while this phenomenon may have been tangible back in the 20th century, data gathered in more recent years looks much more random.

Historically speaking, stocks do increase in price in January, but this effect has become less and less obvious in the last years. Some analysts think that this effect will be non-existent in a few decades. Honestly,  in the last several years, the returns were very low.

HOW TO USE

One explanation is that mutual fund managers will go shopping at the end of December to purchase stocks that have appreciated during the year. That is a deceptive practice.

Simply, some of the investors may be trying to cut their ties to bad investments in order to get a fresh start to the new year. Many people will sell their losers. The more people who know about the January effect, the less of an impact this effect will have. The investors are highly trained so they can improve their profits. If there ever was anything to the January effect, it was a long time ago.

It is the best to achieve your goal step by step instead of diverting off the path every time something like the January effect comes along. Yes, it is still possible to make a profit off the January effect if you’re an experienced investor. But if you are a newcomer you should hold to the basics.