January effect – What is it, definition and concept | 2022

The January effect is a stock market phenomenon that consists of an abnormally high rise in prices in the first days of January, as opposed to the falls that occur in the last days of December of the previous year.

This phenomenon is one of what is known as «Calendar Anomalies» and seems to be between the last day of December and the first five of the following year. Of course, it is not very reliable and, therefore, we must be careful with it.

On the other hand, it tends to affect smaller companies, because their share prices are more volatile. For this same reason, extreme precautions must be taken, since opposite situations can occur and cause us to lose money from our investment.

Causes of the January effect

There are different reasons why the January effect seems to occur. On the one hand, we have the tax hypothesis, since there are investors who sell loss-making securities at the end of the year to pay less tax. In January the opposite effect would occur (rises).

On the other hand, the “window dressing” hypothesis, which can be translated as “purse makeup”. According to this, professional intermediaries carry out a more prudent investment policy at the end of the year. The objective is to offer favorable reports, and the opposite happens in January.

In addition, there are some factors that affect these markets and can cause this phenomenon. For example, investors may believe that a mistake in January can be corrected for the rest of the year and therefore risk, or the effect of the Christmas holidays, which paralyzes stock market activity.

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Benefits for the investor

This effect can generate a series of benefits for the investor. These benefits must be taken into account with some caution.

  • First of all, you can either make an income early in the year or use strategies like futures contracts, index options and the like to make a profit later in the year.
  • Although it is true that this effect goes against the theory of market efficiency, the truth is that it can bring extraordinary income to our investments.
  • Of course, these investments must always be diversified. As we have said before, the actions that it affects are, above all, small companies with a lot of volatility.
  • Although it is not entirely reliable, the truth is that it seems to have occurred in most years since the mid-20th century, although it depends on the country.

January Effect Example: The S&P 500

To finish, we are going to see an example, that of the S&P 500, one of the best-known stock market indices in the US. Its evolution from the middle of the 20th century to the year 2021 revealed the correlation between January and December, at the end of the year.

However, these types of predictions must be taken with great care. In this case, it was observed that only in 88% of the years did the January effect occur. It may seem like a high percentage, but we are talking about possible economic losses and 12% must be taken into account.

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