The January Effect: The Stock Market Myth That Attracts New Investors

In 2005, a stock market study called “The January Effect” found that small-cap stocks tend to outperform in the first month of the year.

Some analysts believe that investors get rid of losing stocks at the end of the year – to offset profit taxes – before buying them back in January.

Others think it’s down to “window dressing,” where money managers dump stocks by the end of the year to present a more optimistic report to clients.

What is the January effect?

The January Effect is not a new phenomenon – it was first noted by investment banker Sidney Wachell in 1942.

At first glance, the data seems to broadly support this theory. From 1890 to 2020, 85 out of 130 years have seen a slight January rally in the US stock market.

The numbers appear to be more optimistic around the world, with Japan Seeing 74% of their starts for the year have been positive and Australia seeing 78% in that period.

Initial investors jumped on the premise, thinking they had discovered a quick win to turn their fortunes around. They were wrong.

The January effect lies between ‘myth and reality’

Over the past decade, the performance of January stocks has slowed significantly. Any “shit of truth” in the January effect, said Ross Mould, investment director at British stockbroker AJ Bell, is between “myth and fact”.

He explained: “The January effect was very clear from 1984 to 1989 – six consecutive, sensational January gains. However, since then the gains have been less clear and uniform – January has made up for losses five times in the last seven years.” Average The monthly gain in January is 0.4%, making it only the seventh best month on average.”

Schroeder’s Head of Strategic Research, Duncan LamontHe wrote, “A fairly accepted rule of thumb in life is that if something seems too good to be true, it probably is.

“An equally important rule of thumb when investing is that unless you can come up with a fundamental reason why something happened, there is no reason to expect it to continue to happen in the future.”

Long-term data on January’s impact is “misleading,” he added, explaining: “If we break things down on a decade-by-decade basis, it becomes clear that these results are largely due to performance several decades in the past.”

The January Effect can be dangerous for untrained traders

With hordes of new people signing up for trading apps every year, it becomes easier for an untrained trader to get themselves into hot water.

The Business of Apps reports that in 2021, 137 million people were using trading apps, up 49% from the previous year.

Equity trading platforms earned $22.8 billion in the year prior, up from $10.9 billion a year earlier.

Educating users to help them avoid pitfalls like the January effect is front and center on many sites — including Freetrade, which launched in 2016.

Gemma Boothroyd is a senior investment writer on the app, saying a big focus is on educating users, from investment guides to Q&A and how much money to invest.

And she cautioned against “myopic opinion” – whether it be in January or throughout the year: “We hear similar thoughts about better trading in May or June because of the old notion that bankers take their vacations. People think certain months will be better based on concepts advance”.

What is the best way to approach investing as a beginner?

“The mindset that is healthier than thinking month after day or day after day is thinking year after year,” Boothroyd said. Our investors are looking for the long term – five years or more.

“It’s not about dancing and gambling, it’s about stepping back and seeing the bigger picture.”

Bothroyd added that preliminary data for the beginning of 2023 from Freetrade’s 700,000 users suggests that education about fair weather trends is working: “While it is too early to draw any conclusions, we are seeing an increase in the popularity of EFT. This may indicate that in contrast to January impact allegations, our investors do not chase the short term.

“Instead, they opt for a more diversified approach, prioritizing a balanced portfolio over some quick wins.”

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