• January effect

    January effect

    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”.

     


  • Easy ESPP Mathematical Formula

    When you are first hired to a new company, the human resource personnel would educate you that Employee Stock Purchase Plan (ESPP) is a fantastic deal etc. She would spend hours explaining how the 15% number  would nest you a profit.

    An ESPP typically works this way:

    1. You contribute to the ESPP from x% of your salary. The contribution is taken out from your paycheck.

    2. At the end of a “purchase period,” usually every 6 months, the employer will purchase company stock for you using your contributions during the purchase period. You get a 15% discount on the purchase price. The employer takes the price of the company stock at the beginning of the purchase period and the price at the end of the purchase period, whichever is lower, and THEN gives you a 15% discount from that price.

    3. Some companies have 2 years lock period, she would have a little harder time to explain to you how that work. This is because with the x% salary and the 15%, this gets a little more complicated. Eventually you will understand the concept, but you will forget it right away because in your mind you don’t have a very concise picture of this whole business.

    Today, I am going to show you a concise math formula to help those engineers to understand it, if you still can’t remember it after reading it, you should quit your engineering job :

    Let date2 be the start of the ESPP cycle, date1 be the end of the cycle.  date1-date2=6 months.  We use daten denote the nth 6 months prior to date1.

    your_current_price=0.85*min(previous_locked_price,price(date1),price(date2))

    and then set the previous_locked_price for the next period:

    previous_locked_price=min(your_current_price,

                             previous_locked_price(date2),

                             previous_locked_price(date3),

                             previous_locked_price(date4),

                             previous_locked_price(date5))


  • Even a stopped clock is right twice a day

    Even a stopped clock is right twice a day

    There are many different ways to predicate stock market.  Some are well known, some are not, but all theories have their true believers. First I will list a few very “reliable rules”. Then I will list a few common but not so reliable ones. For each of the topic below, we will have follow up posts with in depth study and discussions.

    Reliable Rules:

    Rule #1 Buy low and sell high: everyone knows that, this rule for sure is working, I definitely believe it!

    The financial markets are usually efficient. When the markets are not fully efficient, you may benefit from it.

    Insider trading:  This is the most effective winning strategy. Most people including theUS government would agree with me on this one. Recently the government sent billionaire Raj Rajaratnam to 11 years in prison. The government rigorously proved that insider trading is profitable, I have no doubt about that.

    Market manipulation: bear raid, churning, rumors. Note that market manipulation is prohibited in theUnited States under Section 9(a)(2) of the Securities Exchange Act of 1934.

    Not so reliable rules:

    I have crafted this statement even before I have posted this article to cover my rear end: “I’ve been getting loads of emails from people who have lost most of their money and are looking for some direction as to what they might consider doing. Yes, I was right/(or wrong), no one could have anticipated the catastrophic event, but exceptional times need exceptional measures. Etc.”

    January effect: 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.  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 does not always materialize; for example, small stocks underperformed large stocks in January 1982, 1987, 1989 and 1990.

    Presidential Cycle: The first year is the weakest of all four years. Higher returns during the last two years of a Presidential term than the first years.  The expectation is that as a President takes office he begins to implement his proposals and investors, hunker down waiting to see the results.  During the final two years the President becomes more concerned with his re-election and will ‘prime the pump’ in order to secure re-election.

    Halloween indicator: it is a variant of  “Sell in May and go away”. It is the belief that the period from November to April has significantly stronger growth on average than the other months. In such strategies, stocks are sold at the start of May and the proceeds held in cash (e.g. a money market fund); stocks are bought again in the autumn, typically around Halloween.

    January barometer:  it is the hypothesis that stock market performance in January (particularly in theUS) predicts its performance for the rest of the year. So if the stock market rises in January, it is likely to continue to rise by the end of December. Historically if the S&P 500 goes up in January the trend will follow for the rest of the year. Conversely if the S&P falls in January then it will fall for the rest of the year. From 1950 till 1984 both positive and negative prediction had a certainty of about 70% and 90% respectively with 75% in total. After 1985 however, the negative predictive power had been reduced to 50%, or in other words, no predictive powers at all.

    Mark Twain: it is the phenomenon of stock returns in October being lower than in other months. The name comes from the following quotation in Mark Twain’s Pudd’nhead Wilson: “October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”  The 1929, 1987 and 2008 stock market crashes roughly occurred in October.

    Turn of the Month Effect: higher returns around the turn of the month. Turn-of-the-month is defined as beginning with the last trading day of the month and ending with the third trading day of the following month. It is saying that positive returns only in the first half of the month, and the last day of one month and the first three of the next are particularly high. Investors making regular purchases may benefit by scheduling to make those purchases prior to the turn of the month. Nobody knows the reason behind such pattern.

    Monday Effect: Monday tends to be the worst day to be invested in stocks. Suicides are more common on Monday than on any other day. Could the effect be caused by the moods of market participants? People are generally in better moods on Fridays and before holidays, but are generally grumpy on Mondays.

    Super bowl indicator: This is an indicator based on the belief that a Super Bowl win for a team from the old AFL (now American Football Conference AFC) foretells a decline in the stock market for the coming year (bear), and that a win for a team from the old NFL (National Football Conference NFC division) means the stock market will be up for the year (bull). This indicator has been surprisingly accurate (around 85% correct) over the past years.

    Years ending in 5: The DJIA had never had a down year in any year ending in 5. DJIA ended on 12/31/2004 at 10,783 and 12/30/2005 at 10,717, so this trend may have ended with 2005.

    Stock Split Effect: before and after a company announces a stock split, the stock price rises. This is momentum effect because a stock split is as result of the stock risen too high. The stock splits are often viewed by investors as a signal that the company’s stock will continue to rise.

    Merger Effect: the value of the company being acquired tends to rise while the value of the bidding firm tends to fall.

    Bare knees, bull market: The market rises and falls with the length of skirts. In 1987, when designers switched from miniskirts to floor-length skirts just before the market crashed. A similar change also took place in 1929.

    Drug Production Indicator: Stock prices and anti-depressant production are inversely related. This indicator suggests that when the market is rising, fewer people need anti-depressant to heal market-induced problems.

    Holiday Effect: the general strategy is to purchase stocks one or two days prior to a holiday and sell stocks just after the holiday.

    Astrology:  predicting major economic trends as they relate to certain cycles, specifically on the cycles of outer planets; finding the best industry to be in for a particular period of time based on major planetary configurations; identifying the best stocks to own during a particular time period; identifying the best date and time to buy or sell a stock; correlating the Astrological aspect to the movement of stock market in day trading.

    Lunar cycle: stock returns are lower on the days around a full moon than on the days around a new moon.

    Elliott Wave: it is a form of technical analysis that traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors. This principle has many believers, however critics says as follows:

    Technical analyst David Aronson wrote: The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method’s loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.