As we discussed in the marketing timing strategies, January Effect is the oldest and more common accepted ideas. In this article, we expand the topic and look at more details.
Increase in buying securities before the end of the year for a lower price, and selling them in January to generate profit from the price differences. The “January effect” is that American stocks rise much more in January than in any other month of the year. It is called January effect but now the date may be moved earlier because people are buying the stocks earlier to profit from it. One theory explaining this phenomenon is that income tax-sensitive investors sell stocks for tax reasons at year end (such as to claim a capital loss) and reinvest after the first of the year. The second reason is the payment of year end bonuses in January. Some of this bonus money is used to purchase stocks, driving up prices. The third reason is that may people max out the retirement contribution at the end of a year and contribute to their retirement saving at the start of the year. The January effect may not be always true; for example, small stocks underperformed large stocks in January 1982, 1987, 1989 and 1990.
Sidney Wachtel discovered the phenomenon in the 1940s, but it wasn’t until the 1970s that anybody took much notice. Many subsequent researchers have made many refinements and produced several ingenious explanations, usually suggesting that shares are dumped in December in response to tax or reporting requirements at year’s end. The January effect is a challenge to the efficient markets hypothesis. A reasonably bold version of that hypothesis is that you can’t beat the market without inside information. All publicly available information—including corporate accounts, price history, and what month of the year it is—is already taken into account in the market price. January Effect says “buy on Dec. 31 and sell on Jan. 31”, it just shouldn’t yield consistent returns.
The history may indicate a very small, inconsistent inefficiency in the stock market. Exploiting a small efficiency may be all it needs for a professional trader. For average Joe, there are many other bigger mistakes he may make. Since January Effect is well known, there may be a very large number of investors making their bets based on the January Effect. Can small number of smart investors make money from mistakes made from a larger pool of average investors? It also won’t take long for all the obvious mistakes to disappear, because they’ve been so exploited. The date of January Effect would keep shifting until you are no longer sure there is such an effect.
One closing thought, if I were to start a family of mutual fund or ETF, I certainly would have one for “no-January-effect Russell 2000” , another for “January-effect Russell 2000”.