The January effect is upon us

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The January effect refers to a historical trend for the stock market to increase for the first trading week of January. It is generally caused because people often sell stocks in late December to take advantage of tax maneuvers. It also occurs due to fresh optimism for the New Year. The January effect has traditionally been more accurate for smaller companies rather than large cap stocks.

There are two points of caution however, when looking at the January effect as a strategy. The first is that every investor knows about the January effect and therefore, it is already priced in to the stocks. The other important point about the January effect phenomenon is that if you look at this past December, the stock market actually finished up. I am referencing the Dow Jones Industrial Average for this, but the others had similar trading patterns. The Dow finished the month of December up almost 5% and even rose slightly in the last trading week of the month. If the January effect exists partly because of a sell-off in late December, then that simply did not happen this time.

It is probably not a good idea to formulate your investment strategy for January based on the January effect. That is not to say that stocks won’t finish up for the first five trading days of the year or for January in general. In fact, it seems like the economy is gaining strength and this may very well impact the stock market in a positive way for this month. However, I would rather base my strategy on a growing American economy instead of the January effect.