What Is the “January Effect”?
January is here, which means the financial media is rife with references to the so-called “January effect.”
You’ve likely heard of this phenomenon. But if not, it goes something like this…
Most investors start selling their losing positions in December so they can deduct the losses on their taxes.
This can create a pulldown effect on stocks.
However, in January, many investors jump back into those previously sold positions. This supposedly leads to a rally in stocks during the first month of the year.
It’s an interesting theory… but is that all it is?
Below is a table showing the performance of the Dow Jones Industrial Average during each January of the past 10 years.
As you can see, the results are fairly lackluster…
On average, Dow stocks have lost nearly nine-tenths of a percent in January.
Not a big deal… but it’s very different from what the January effect suggests.
What about further back? Consider the 20-year period from 1980 to 1999.
Running those numbers, things do start to look a bit different. In fact, over those two decades, stocks booked an average 1.46% gain in January…
Even more interesting, 15 out of the 20 years saw positive January gains.
So what gives? Did the January effect exist in the past… and then fade away over time?
As active stock trading gained traction over the past several years with online brokerages – which created easier access for everyday investors – these sorts of effects have disappeared.
In fact, the efficient market hypothesis insists that almost any trading advantage will fade over time as more investors become aware of it.
After all… if the January effect was reliable and well-known, everyone would try to take advantage of it, which would ultimately lead to the effect disappearing.
But there is some data that suggest the January effect lives on in certain pockets of the market. For example, studies have found that there is a stronger January effect among small caps than other stocks.
However, a look at the data over recent years suggests that this too has faded away.
Just take a look at the performance data for the Russell 2000 Index…
In reality, the story looks even worse for small caps than it does for large caps.
Here’s the takeaway…
Don’t bother listening to the popular myths that investors throw around on the internet. You’ll more likely hurt your returns trying to follow tired advice.
Instead, stick to strategies that work consistently over time… not just once every few years.
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