Stock Prices: January Effect on Stock Prices: Finance Trading Times

Stock Prices: January Effect on Stock Prices

Continuing further from the first part of this article on January Effect on Stock Prices, here is the second part:

A number of detailed explanations have been suggested for the observed January effect,
but few only the following give a reasonable justification:

• Tax loss selling by investors


Taxes are the biggest concern for traders and investors across the world.
In the US, December is end of tax-year. Hence, at the end of the tax-year, there is wide spread selling of the stocks which have 'lost money' to capture the capital gain, driving down the prices, presumably below true value, in December, and a buying back of the same stocks in January, resulting in the high returns.

Then, there is also a “wash sales rules” which prevents an investor from selling and buying back the same stock within 45 days, and there has to be some substitution among the stocks.
Thus investor X sells stock A and investor Y sells stock B, but when it comes time to buy back the stock, investor X buys stock B and investor Y buys stock A.

It will be interesting to note the same effect happening in the month of March to April for countries like India, where the financial year ends in the month of March. Moreover, there is no such rule like “Wash Sales Rule” in India, so traders can keep on betting on the same stocks again and again.

• A second reasoning is that the January effect is related to institutional trading behavior around the turn of the years. It has been noted, for example, that ratio of buys to sells for institutions drops significantly below average in the days before the turn of the year and picks to above average in the months that follow. However, once again to repeat, it has only been observed historically. There is no guarantee that the same will continue further.

• A third and very important Behavioural Aspect that has been observed is due to Christmas and Holiday Season. Since it is festival and holiday time in the US (and other western countries), people need money for spending – either for buying gifts for their loved ones, making new purchases for self and family, or for going on enjoying the holidays. All this results in huge spending and the investors usually try to take the money out of their investments. Hence there is wide spread selling. This again causes stock prices to tumble just before festive season, i.e. early and mid-December. The same investors will again come back in January for putting in fresh money and starting again, hence the January effect predominates.

Not only for USA, the January effect is prominent for other countries as well. Here is the graph showing the historical returns in the month of January as compared to other months for different countries across the globe.



However, all the observation and data dates back to 1927 and is primarily concerned with USA stock markets. It forms an interesting case for other countries like India because firstly, the Indian financial year is different from the US financial year and secondly, the festive season is in October-November (Diwali/Dusshera). So things may be different for stock markets like India.
However, the Indian stock markets are still dominated by FII and other foreign investments, so this effect can be seen in India too.
We are about to enter January, so one may try his luck if he or she wishes - off course at his own risk ! :-)
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3 Comments: Post your Comments

Anonymous said...(on 18 December 2007 at 21:30 )  

Hello Shobhit,

I need a lump some amount of around 45K to pay the LIC permiums every Jan...
So normally what I do is open a RD in december itself to avoid the last minute trouble
The interset rate that was offered last year was 6% ...where as this year for a period of 12 months my bank offers me 8% interest

My recurring amnt is 4000 per month..so the question is instead of opening an recurring deposit...should i do the fixed deposit just like an SIP..

Like in January i will open a FD for 12 mnths
In February I Will opne FD for 11 Months

like wise...
so effectively in next January I will be having the required amount...

Here are the interest rates offered by my bank on the fixed deposits for the specified period.

Maturity Slabs
7 days - 14 days Nil
15 days - 30 days 5.00%
31 days - 45 days 5.50%
46 days - 90 days 6.00%
91days - 6 months 6.50%
> 6 months upto 9 months7.00%
>9 months upto 359 days 8.00%
360 days 8.75%
361 days upto 499 days 8.50%


When I calculated i found that this way i can earn almost 3000 more on the amnt of 4000
Is this correct or is there any flaw which i have missed out..


Please guide me...I need to start something in Coming January

Thanks
Radhika

Investment n Trading Advisor said...(on 27 December 2007 at 04:18 )  

Hi Radhika,

Sorry for missing out on your question.

It is usually a good option to go for a Fixed deposit account rather than recurring account, because the money in FD stays invested for a long time and hence earn a lot more interest. Hence, it's a good option to go for monthly FD with varying maturities as you suggested.

However, the problem is that banks may change the FD rate any time. So you may have to increase or decrease you amount if the bank does that. That is the uncertainiity you will face in this strategy. but overall, this will definitely be better than the RD.

But I am more interested in knowing what kind of LIC policy you are having which needs 45 K per annum investment???
I would suggest you to go through this post (http://invest-n-trade.blogspot.com/2007/12/insurance-agents-insurance-policies-and.html)

Thanks!

Anonymous said...(on 30 December 2007 at 22:35 )  

Hello Shobhit!
Thanks for replying...I was on leave so could not reply to your question..

I have read all your articles..
LIC policy is Jeevan Anand for 5 lacs...

I too do not like paying heavy premiums..but for this i dont have any option as this policy was taken by my parents( I didn even knew at that time, what is going on)

I will say this is the case with almost all the youngsters like me that they have to continue with their parents choice( for investment)..

Any ways....but I have not taken any Policy when I started looking into my own finances...

Thanks again for your reply

Radhika

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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