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The January Effect

Being that it’s now January again, I thought we should take a look at something known as the January Effect – when stocks see increases in January for a variety of reasons. If you were to buy into the smallest 10% of U.S. stocks on the last day of December each year and then sold a month later, you would earn an average return of 11.3% (in that one month!) going all the way back to 1926. You read that right, the January effect, at least empirically, is very real and very lucrative. So, why doesn’t everyone do it? It’s because the smallest 10% are utter crap and it’s a case of statistics being twisted to show what people, financial people, want them to show. The best example from a two-year old article [3] is of a software company called OCG Technology that spiked 2400% in January of 1992 (incidentally, it’s not around anymore under that same name).

There are other reasons why the January Effect doesn’t really work such as commissions and the fact that some of these companies have such low trade volume that any action would severely mess up the numbers. The article states that even if you were to pay only 12.5 cents a share, it would drop your return from 11.3% to a mere 2.4%.

Now that you know it’s really a bunch of statistical hocus pocus, I thought I’d go into the biggest theory as to why the January Effect may be legitimate. It has to do with the whole tax wash rule [4] where you can use your losses to offset your gains. The theory is that there will be some investors out there who are selling, thus suppressing the price of the stock, and then re-buying one month later. Now extrapolate that to the bigger fish, such as mutual funds, and you can start to see why people start believing in the January Effect.

So, can you take advantage of the January Effect? Doesn’t look like it…