The January Effect Market Anomaly

The January effect is an anomaly that comes from this pattern of increased trading volume, which leads to higher share prices in the first few weeks of January

Various market anomalies take place in the stock market at different intervals and based on different situations. However, one of the commonest kinds are those that are based on calendar effects.

Calendar effects are anomalies that are linked to specific times during the calendar year. They could be weekly, monthly, and yearly. An example of an anomaly that falls under calendar effects is the January effect.

Without any explanation, you can tell that January effects take place in January. There are different ways the January effect comes to play but the first is borne out of the assumption that the stocks that didn’t perform so well in the fourth quarter of the previous year, would outperform the markets in January of the incoming year.

In other words, the January effect is an anomaly that comes from this pattern of increased trading volume, which leads to higher share prices in the first few weeks of January (sometimes in the last week of December as well.) However, this phase barely lasts beyond two weeks.

One important thing to note is that this effect is particularly common in smaller companies. For one, smaller companies have a higher growth potential. Larger companies can only grow so much because of their already large size.

For this reason, some regard the January effect as the “Small-Firm-in-January Effect.” A reason for this is that the stocks of small companies, being volatile, would have crashed (reduced in value) towards the end of the year.

This is because of the tax-loss sales that would be made and how profits might have been offset at the end of the year. Consequently, it is natural that many investors will want to avoid buying poor stocks in the fourth quarter and just wait until January to avoid being part of this tax-loss selling.

Another way to look at this is that because investors would naturally need more money to go through the holiday season, stocks would be disposed to obtain capital gains.

By January, many of the investors and traders would be on their way back into the market and this increased demand for shares would have the price and value, rising in no time. At this point, the New Year stock purchases would have brought the stocks back to their appropriate price level.

Traders who understand this anomaly might be able to leverage it by purchasing low in December after shares have been disposed and then selling in January just as the prices are rising.

However, because it is still an anomaly, it isn’t always bound to follow prescribed patterns. The gains might not be worth it after all.

Written by Lawretta Egba.