Markets: The January Effect

The January effect has several variants. Among these:

• If the first three trading days show a net gain, January will be up.
• If the first five trading days show a net gain, January will be up.
• If January is up, the year will be up.

These three January effects have been examined in detail in an article at TheStreet.com. It turns out that, on average, all three are valid indicators. Also, the first three days and the first five days are indicators for the entire year.

Some of the correlations have what I consider to be marginal significance. For example, the 82 Januaries studied have produced gains 67% of the time. For the years where the first three days of January resulted in a higher market, 73% of the Januaries were up. I wouldn't trade based on that marginal improvement.

The 81 years studied resulted in 66% with gains. Looking only at years with January up, the percentage of years with gains jumps to 83%. This impies that a good strategy is to be more aggressive in years when January shows gains. The probability is less than two in 10 that you will have a losing year.

The most remarkable results were obtained for years when January was down, like this year. Only 34% of all 81 years were down. For years when January was down, the odds jump to 69% that the year will be down, doubling the probability of a bad year.

A member of the contrary club, 2008 had a down January and an up year. Remember that the January effect has little significance on a single-year basis. It can be helpful applied every year over a long period of time, like 15 or 20 years.

In the article, the Dow was studied for the years 1929-2009, 1969-2009 and 1989-2009. The January effect was found to be consistent over the three different time periods.

Disclosure: No positions at present, but index ETFs are traded (long and short) from time to time.