Let’s face it, January is a very dull month. Diwali is gone, Christmas is another eleven months down the road, and your bank account looks underfed. What’s more, that festive feeling that had your mojo moving seems more like an inconvenience as you try to adjust to your daily commute. Yes Sir, that’s why they …
What Traders Need to Know about the January Effect
Let’s face it, January is a very dull month. Diwali is gone, Christmas is another eleven months down the road, and your bank account looks underfed. What’s more, that festive feeling that had your mojo moving seems more like an inconvenience as you try to adjust to your daily commute. Yes Sir, that’s why they call it the “January Blues.”
Amongst all of these adverse tidings, there is some good news for stock market lovers: January is widely recognized as one of the strongest-performing months of the year. This phenomenon is known as the “January effect,” or the “January Barometer.” It references a tendency for stock prices to move higher in January.
This is an observation made from stock return data which was first studied by Sidney Wachtel in 1942. What he saw was a repetition appearing in data going back to 1925. A phenomenon characterized by higher than expected positive returns led by small-cap companies outperforming large-cap companies in the first half of January.
Please keep in mind that this is a hypothesis rather than a cause-effect relationship and there are a number of reasons why the stock market may generally move higher during the month of January.
In our earlier article on the January Effect, we looked over the basics and main theories that have tried to explain why this phenomenon happens. We decided to write a follow-up article to delve even deeper into it.
We know one of the best ways to understand the market and the trends affecting it is to hear it from the experts. These are brokers who have been in the market for years and that have experienced the January Effect themselves.
We have asked them a series of questions on this January market trend. This is what they shared with us:
What Traders Need to Know about the January Effect
Why does the January Effect happen?
How should a Trader Prepare for the January Effect?
How are Trades Affected by it?
Which stocks are more affected by it?
Are there any precautions to be taken during this phenomenon?
Why does the January Effect not happen every year?
What is the January Barometer? Is it Reliable?
Why does the January Effect happen?
The January Effect can be described as a phenomenon in the stock market. It may be triggered by a new money being put to work by both retail and by institutional investors, making purchases that significantly increase their investment portfolios. This is referred to as a calendar effect and arises from the tendency of people to invest to start the new year.
“The January effect occurs because Traders are still on vacation the last days of December and resume positions with volumes that used to the days of the previous year towards the second week of January of the current year. This added to the expectations for a new year with a lot of movement at the macroeconomic level and with the firm certainty that the US Federal Reserve will begin to lower rates the moment inflation begins to give way.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“The January Effect occurs due to many factors. One of them is year-end bonuses when retail traders start investing those bonuses in the market. Another reason is just to start from scratch as a new year resolution. We all set goals to be achieved during the year and make conclusions at the end so many traders set their goals and launch the rocket in January hoping to get to the moon.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets
“From a psychological point of view, the January effect is justified as a reaction to the action affecting capital market participants in December, when a huge asset sale occurs related to settlement issues with regard to stock exchange taxes in the previous year. It can therefore be said that the January Effect is a kind of market rebound, driven by New Year’s supply.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member.
We asked Jay Joymungul, Market Analyst at Tradeview Markets, about the January Effect. Here is what he told us:
“There are several vitiating factors to it. We can’t be sure but a possible axiom is investors’ Psychology. One of the most common New Year’s resolutions across the board is money management where we see more and more people investing their hard-earned money driving up stock prices. In simple economics more stock bought equals higher stock prices remember supply and demand in our economics lesson.
Bonuses are less likely to be spent like salaries; research made by the same bigwigs shows that bonuses have a higher chance of being invested, resulting in more money on the market which typically tends to be at the end of December.
Window dressing is another rationale where an Institutional investor such as a hedge fund or mutual fund manager goes shopping for outperforming stocks at the end of the year by selling stocks with large losses and buying soaring stocks to improve the appearance of the fund’s performance to deceive individual investors that they have a high-flying portfolio.
Tax Loss Harvesting is another connecting explanation where Investor dumps poor performing stocks during the last quarter of the tax year and this allows them to shoehorn their losses into their tax returns for the year, what happens next is that the selling pressure drives prices down in December and when it recovers back in January, they buy back which is referred to repurchasing.
You must be wondering if you can profit from the January effect
There is room for short-term trades and trying to exploit the effect, while there is evidence the stock prices will increase in January there’s no telling which companies will increase in price, or which day it’ll happen. Always carry out diligent research!
How should a Trader Prepare for the January Effect?
Once traders are fully aware of the January Effect, they should prepare an appropriate plan. Oliwier Taraszkiewicz, has given us 2 main tips on how to prepare.
- Traders should have accumulated sufficient funds by that time, which can be used immediately, as the January Effect phenomenon can be very dynamic.
- It is worth considering which assets will perform best in such a situation. In order to do this, it is essential to realize what the driving force is. Most often it is due to changes in laws and taxes, new trends and the refinement of investment strategies by many market players.
“A professional trader must take into account his maximum possible loss level and of course a Take Profit and a Stop loss in each position he decides to open in the market. It’s all about risk management.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“Traders must be clear about market fluctuations, and prepare for a possible increase in demand.”
Ramiro Astudillo, Senior Analyst at Tradeview Markets.
“Easiest way is to look back at the previous year and go through all the ups and downs in trading strategies used. Make a thorough analysis and get ready for the new trading year. Another option is to use a buy and hold strategy for long term trading investment goals.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
How are Trades Affected by it?
“Without doubt, retail traders are affected by the January Effect. This phenomenon is so
strong that it tends to affect the entire market with many individual investors on board.
As a result, traders with a particular presence in the stock market stand to gain by joining the
trend. If they already have a position in the stock market or acquire one at the appropriate
time, it can increase in value if the January Effect materializes successfully. That is why it is so important to be aware of this effect.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member.
“It is a question of the volume of trading in the market, traders that are in retail tend to put spikes with the trend and this trend is undoubtedly dictated by market professionals.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“Retail traders are affected in a positive way. They start the year from a clean sheet and invest funds saved from year-end bonuses and other savings. The January Effect is considered to be one of the best months for all traders overall. All traders start the year fresh and start buying new trading instruments.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
“The power of the January Effect affects the entire capital market, especially the stock market. This phenomenon is mainly caused by institutional investors and large market players taking new positions at the beginning of the year. These trades drive volatility, which directly affects the value of the portfolio of non-retail traders. This works the same as for retail traders, but to an even greater extent.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member.
“If we see it by trading volume the first two weeks there could be a lower volume than these professional brokers are usually used to trading otherwise the market continues in its traditional dynamic and this year specifically with the decision of the Federal Reserve towards the last week of January to return to the volumes in a very very very relevant way.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
Which stocks are more affected by it?
“Stocks in general tend to behave according to fundamental and technical factors that directly affect these actions. We cannot necessarily make an assertion of which stock could rise in the short term or fall in its defect but if we can take positions in indices since there we are incurring a systemic and non-specific risk.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
When we spoke with Luis Pinto, a Senior Analyst at Tradeview Markets. This is what he said:
- Traders should avoid most of the bad performers of 2022 because we are still facing issues of inflation and recession. There are stocks with more than 60% losses at 2022 year-end.
- Don’t try to be a hero with calls on sectors like ARKK, or growth stocks. Stay away also part of discretionary and energy stocks. Avoid stocks without a medium or long-term positive tendency.
- Also take into account that small or median cap can hold on heightened inflation, because of the scale economy, but will go lower faster in a recession environment.
- Avoid stocks with a lot of debt, low margins, and bad income.
“Small cap stocks are affected positively and tend to outperform during that month compared to momentum stocks that do not show best results in January.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
Are there any precautions to be taken during this phenomenon?
“It is always important to remember that historical performance is no guarantee of similar
results in the future. Nevertheless, history likes to repeat itself, including in the market. Of course, it always takes a slightly different form and it is difficult to find two identical situations,
but one can see certain patterns repeating themselves quite often. The January Effect is
said to be one of them, although whether it will materialize in reality time will tell.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member.
“All professional traders must take precautions and go beyond risk management as always being informed of everything that is happening globally in political and economic terms of course.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“Using buy and hold strategy for long term investments and being careful when it comes to short-term predictions”.
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
Why does the January Effect not happen every year?
“It all depends on the region of the world and what condition the economy is in. The recent
turmoil associated with, for example, the outbreak of the COVID-19 pandemic has meant
that the January Effect has been minimized or not seen at all in many stock exchanges.
Even today, the global economy is facing many problems, but the situation is much different
than it was one or two years ago. For this reason, many traders are looking forward to the
January Effect this year, even though there is still a lot of uncertainty in the market.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member
“I think it varies according to the progress of each year, and to a greater or lesser extent if there are these changes.”
Ramiro Astudillo, Senior Analyst at Tradeview Markets.
“There must be many factors including steps of the year and for income or tax purposes in addition to the start of Holidays or vacation season and of course expectations about what direction the market should take during the current year. It should not necessarily be the same as the rest of the months of the market.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“It is considered a calendar theory the same as Santa Claus Rally so no one truly knows why they happen and they cannot be predicted.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
What is the January Barometer? Is it Reliable?
Have you heard of the phrase “As goes January, so goes the rest of the year”? This is strictly related to the January Barometer theory. It was first mentioned by Yale Hirsch in 1972, who studied the S&P 500.
The January Barometer is the theory that the stock market’s performance in January reflects the results for the rest of the year. This means that if the stock market rises in January, it is likely to continue to rise until the end of December. On the other hand, if the stock market falls in January, the market is facing a tough year.
“Theoretically, the January Barometer predicts overall market performance for the entire year. So if January is positive then we can expect a bull market to prevail during the year. In case January is negative we should be prepared for bear markets occurring often.”
Bekhruz Kadyrov, Senior Analyst at Tradeview Markets.
“Initially, the results of the predictions had a high success rate, but in the following decades their power was reduced and started to oscillate around 50%, which hijacked confidence in the January Barometer.”
Oliwier Taraszkiewicz, Tradeviews Business Development and Sales Team Member.
“The market barometer in January is not necessarily what indicates the trend for the rest of the year, so only one month in which there must be adjustments and a strategy must be drawn up to incur good negotiation for the rest of the year.”
Alejandro Sanchez Villanueva, Senior Customer Advocate at Tradeview Markets.
“The Barometer analyzes the annual returns according to the movement in January, it is a way of measuring, which may or may not be reliable, it should be taken as another tool.”
Ramiro Astudillo, Senior Analyst at Tradeview Markets.
Researchers have found that “the January barometer is an excellent bearish indicator when January is a down month, but it is a poor bullish indicator when January is an up month.” Lawrence D. Brown and Liyu Lou suggested in their paper that “investors should treat a down January as a signal to stay out of the market, but that they should not treat an up January as a buy signal for the next 11 months.”
Keep in mind that January is often the strongest month of the year, so looking at the returns for the 11 months excluding January will often be weaker precisely because an often strongly performing January is excluded.
Feel and dive into the January Effect with Tradeview Markets. Open a Real Account to start trading or try a free demo account to trade without risk.
