Daily Gains Letter

January Effect

The “January effect” is a seasonal anomaly in the stock market where small-cap stocks increase in January more than in any other month (though more recently, the January effect phenomena has been observed between December 15 and March 12). This creates a short-term window whereby investors can buy beaten-up small-cap stocks for lower prices in December and sell them after they rebound early in the New Year.

The January effect was first observed by investment banker Sidney B. Wachtel and was published in his 1942 paper, “Certain Observations on Seasonal Movements in Stock Prices,” which appeared in The Journal of Business of the University of Chicago. In his article, Wachtel shows that since 1925, small-cap stocks have outperformed the broader market in the month of January.

The most common theory explaining the January effect is that tax-sensitive investors sell certain equities at the end of the year and reinvest in the new year. Large-cap stocks can typically absorb a sell-off, but most small-cap stocks cannot, hence the decline in price.

How to Play Seasonal Anomalies for Profit

Anomalies for ProfitAs all investors know, no two equities march to the same drum. This would then mean that, technically, it should be impossible to predict future returns based on readily available information. However, this might not be entirely true, as it turns out there may be something to be said for some seasonal investing patterns after all. First off, when it comes to gathering statistics, there’s no better place to look than the stock markets. Monthly price data for equities on the New York Stock Exchange (NYSE) goes back to the early 1900s and data from the other indices goes back to their infancy. So it’s possible to gather objective data and weed out irregularities. One of the most ... Read More