What is the January Effect?
The term January Effect refers to a tendency for the stock market to dip sharply at the end of December, only to rebound significantly during the first weeks of January. Historically, smaller companies have shown much faster recovery than larger companies during this time period. Investment professionals refer to smaller company stocks as small-caps, and larger company stocks as mid-caps or large-caps. The January Effect applies mainly to small-cap or mid-cap stocks, because large-cap stocks are rarely sold off in December and generally more stable. Stockholders regularly face special taxation called a capital gains tax. This tax is based largely on the stockholder’s financial state at the end of December. For this reason, many small-cap stockholders look for ways to avoid being taxed on non-profitable stocks. If stockholders can sell off these shares before the following year begins, their capital gains taxes should be lower. This has historically led to a massive selling binge during
The January effect is a term given to the tendency of the US stock market to rise in the month of January. In particular, small cap stocks — generally those with a market capitalization of less than 2 billion USD — will rise more than mid cap and larger cap stocks. The rationale for the January effect is that investors often sell positions in December with the intent of creating tax losses that can be written off, and then buy them back in January. There is some evidence for that, as the January effect does not seem to be in place prior to 1913, the year the income tax was introduced. Is the January Effect Real? There is much debate as to whether or not the January Effect is real. Meaning do stocks actually rise in January? The chart below, courtesy of World Beta, suggests they do. The chart shows the results of trading the January effect over the past 80 years. The red line represents buying and holding the bottom 20% of the US stock market during January of each year; the blue line
The January effect is the increase in the price of stocks in the first few days of January after falling in the last two weeks of December. The January effect is believed to be affecting small cap stocks more than large and mid cap stocks. Some people have tried to link investor’s psychology and mood to the January effect but up until now, no obvious reasons are known for the cause of the January effect. One of the most popular explanations for the January effect states that investors who have sold their stocks in the last two weeks of December because of wanting to create tax losses that offsets capital gains rush back to buying the stocks in the first few days of January.
The month of January in the stock market has strong significance in predicting the trend of the stock market for the rest of the calendar year. This phenomena occurs between the last trading day in December of the previous year and the fifth trading day of the new year in January. The January Effect is a result of tax-loss selling which causes investors to sell their losing positions at the end of December. The January Effect is predicated on the idea that these stocks, which have been sold off to realize the tax losses, will be at a discount to their market value. Bargain hunters step in and load up on these laggards and this creates buying pressure in the market. Statistics from the first five Trading days in January When the S&P500 has a net positive gain in the first five trading days of the year, there is about an 86% chance that the stock market will rise for the year, it has worked in 31 out of the last 36 years (as of 2006). The five exceptions to this rule were in 1966, 1973,
