While the holidays may be coming to an end, the market is just kicking into gear for the new year.
January is a busy time in the stock market, particularly for small-cap stocks. The beginning of the year is marked with some big price movement for small-cap stocks, a phenomenon known as the January Effect.
Here, I’ll offer you a primer on this seasonal stock happening, including what the January Effect is and how it can affect your choices when making swing trades.
What Is the January Effect?
In spite of the name, the January Effect actually starts in December.
While shoppers are busy making merry and spending up a storm in the retail world during December, it’s typically kind of a downer month in the market. Many stocks experience price drops, which is the beginning of what becomes the January Effect.
Why does this happen? One of the most commonly accepted reasons is that it’s due to tax loss selling.
As the year draws to a close, traders often exit losing positions in stocks in order to claim capital losses.
There’s another silver lining to selling off the losers: they’ll also have extra cash from selling to reinvest in the new year.
So what happens is twofold: The lowering prices during December can attract new buyers, and when January comes, there’s big optimism and energy in the market as traders get back into gear.
The overall result is that in January, security prices go up. Voila: the January Effect.
Some analysts claim that the January Effect has been less prominent in recent years due to changing saving habits that nullify the need to claim those losses. However, it’s still a phenomenon followed by enough traders that it still has an impact on the market!
And no, the January Effect isn’t just a general feeling in the market: it’s a documented phenomenon. Studies have proven that during January, the average return is markedly higher than other times of the year.
However, this isn’t just across the board. As it turns out, the January effect is most prevalent with small-cap stocks.
The January Effect: A Small-cap Phenomenon
The January Effect’s prevalence in the small-cap world has been a matter of public knowledge since the 1940s. That’s when Sidney Wachtel, an investment banker, wrote an article entitled Certain Observations on Seasonal Movements in Stock Prices.
In the article, he noted that small-cap stocks tend to outpace the market at large during January. But why?
Most likely because small-cap stocks are less liquid. Liquidity refers to how quickly/easily a stock can be bought or sold in the market without having an impact on the price.
Simply put, the size of small-cap stocks makes them more susceptible to quicker price shifts than large-cap stocks, so they are quicker to reflect price changes due to the January Effect.
Advantages of the January Effect for Swing Traders
How can the January Effect be used to your advantage as a swing trader? Here are some of the many benefits:
- Cut your losses. If you currently hold a position in a losing stock and the year is coming to a close, now might be the time to exit your position with the knowledge that you can make the most of your losses by claiming them on your taxes next year.
- Start fresh in the new year. Cutting your losses never feels good, but there can be benefits. Not only are you releasing the stress of being in a losing position, but you’ll have more money to reinvest in the market in stocks that are hopefully poised for better things.
- A reliable seasonal phenomenon. There’s a lot that’s unknown in the market, so it can be comforting to know that December and January bring this predictable price change phenomenon.
As a swing trader, knowing that prices tend to go down in December and back up in January can help you stay calm in the face of price fluctuations, and they can help you figure out advantageous entry and exit points that can potentially maximize your profits.
How to Make the Most of the January Effect
Simply knowing about the January Effect isn’t instantly going to add up to wins in the market, but it can be used to give you an edge.
Here are some tips for making the most of the January Effect …
Look at the small caps. Large-cap stocks tend to remain more stable in price and will be less affected by the January Effect. So for the best results, narrow your focus on small-cap stocks.
Focus on a specific sector. Don’t spread yourself too thin. Focus on a specific sector so that you can perform detailed fundamental and technical analysis to determine what stocks are experiencing price movement during these times and why.
Make a trading plan. A detailed trading plan can help you make the most of every trade at any time of year, but particularly during the January Effect. With your trading plan, you’ll detail your entry and exit points for the trade, so that you can execute market orders at the optimal price points.
As a swing trader, a trading plan is key because you want to do the research so that you can figure out your desired outcome for a trade.
Then, rather than slavishly following every tick of a stock, you can check in periodically to see if it’s performing according to plan. This allows you to re-review on a regular basis as you monitor the stock’s movement.
Swing Trading with SwingTrades
Now you’ve learned about how the January Effect might help you — but how can you stay updated on the best opportunities and figure out what stocks to trade?
To make the most educated decisions, you need to have a strong foundation of knowledge. This is what will help you create your own watchlists and find stocks like this before people are posting about them on the major finance sites.
If you want to learn how to become a self-sufficient swing trader, you may be interested in becoming one of my protégés.
SwingTrades with Paul Scolardi
My real name is Paul Scolardi, but my trading track record — plus my signature Clark Kent style glasses — have earned me the nickname “The Superman of Stocks.”
Over the years, I’ve developed a method of seeking out stocks before they reach their peak. Using this method, I’m a self-made millionaire.*
I now share my strategy and have taught 1,400 students in over 50 countries. One of my students reports making over $1 million dollars in a year and half after learning my strategy.
If you are interested in learning how to choose stocks ahead of the curve, I recorded a free video where I share my one-word secret that can unlock these massive winners. Click below to watch this free video.