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What is the January effect?


The January effect refers to either of two phenomena, one potentially more profitable for investors than the other. The term is often used as shorthand for a perceived tendency of stocks to do particularly well during the first month of the year. By buying stocks late in December and selling at the end of January, the thinking goes, investors can book decent gains. The key word here is “perceived.” Over the last 40 years the benchmark Standard & Poor’s 500-stock index has risen about 1 percent in January, slightly more than an average month but nothing to write home about or bet your retirement fund on.

The January effect also describes a pattern in which stocks of smaller companies outperform their bigger counterparts during the month. This is a more robust tendency and has been observed going back nearly a century. One reason often proposed for it is heavy selling in December to lock in capital losses for tax purposes. Shares of smaller companies are likely to trade with less volume than big stocks, so tax-loss selling can result in exaggerated price declines, the theory goes. Once the selling abates, the stocks pop back up.

A simpler explanation is that investors’ spirits are riding high after the holidays as they look forward to a new year, so they are more inclined to take a flier in January. Smaller stocks, with their reputation for being more volatile, risky propositions, are obvious beneficiaries of this feel-good factor. Whatever the January effect is and whatever the reason for it, the calendar shouldn’t be your primary reason to buy or sell any asset. Still, if you’re planning to buy a particular stock, especially something small and beaten down, you could probably do worse than to buy it just before New Year’s Eve.

-Conrad de Aenlle