An Introduction to the January Effect

If you are a trader it is possible that you have already heard of the “January Effect”. In case you haven’t, we will go over the basics too! Grab your holiday hot cocoa, sit tight on your favorite couch and get ready to dive in! 

The January effect is a phenomenon where the stock market rises in January in what appears to be a statistically significant percentage of the time. This phenomenon is a nuanced anomaly as it does not happen every year and generally affects stocks with lower market capitalizations, In fact some have referred to it as “the small firm in January effect”. Sometimes the January Effect follows a decrease in prices in December, followed by an increase in demand in the New Year. 

The January Effect was first noticed by Sidney Watchel in 1942 when he was studying market returns from 1925 onwards. Years later, this was proven by other traders as well as academics.

There are many theories out there that try to explain why this effect happens, why it mostly affects small-cap companies, and why it does not happen every year. Below you can find some of the most outlined theories. Keep in mind that no one really knows which is the exact explanation for the January Effect. 

• Tax Loss Harvesting Theory: According to this theory, the January effect is the result of a year/end tax loss caused by traders selling positions to gain tax benefits in November and December and then buying them all back in January.

1. The Holiday Bonus: Believe it or not this theory has a lot to do with Trader’s psychology and the simple fact that investors and traders use their Holiday bonuses to buy assets in January. Others say that January is the month when most traders look over their goals for the new year and increase their trading activity. 

1. Institutional Marketing: Managers typically sell risk positions at the end of the year to keep them off the company’s annual reports, then repurchase them in January.

• Self-fulfilling Prophecy: Traders buy shares based on the belief that shares will rise in value due to the January Effect, resulting in shares rising…

We will dive deeper in the January Effect on our next article developed with our experts. Those who work in markets have witnessed this effect over the years!

However, in case you want to know even more about the January Effect from an academic perspective, we have also found some very interesting papers on the matter: 

• The January Effect by Mark Haug and Mark Hirschey: On their paper they found that the January Effect is relatively consistent over the years. During their research they looked at the Tax Reform Act of 1986 and also took a look at the markets (taking U.S. Equity Documents as their main research base). 

• Richard H. Thaler in his Book “Anomalies”, analyzes the January Effect as an economic anomaly. You can find his insights on the January Effect Here. 

• The Evolution of the January Effect by Nicholas Moller and Shlomo Zilca: The authors found that there are higher returns in the first part of January and lower in the second half of the month. The magnitude of the returns at the beginning of the month tend to keep the January Effect unchanged regardless of the lower behavior for the rest of the month. 

Live the January Effect by yourself! Open a Real Account and start trading or Try a Demo Account and practice without Risk with Tradeview Markets.