How to Profit from the January Effect

How it Works

Stock Market Bull

Photo by MV Hargan

For those of you who aren’t familiar with The January Effect or a Santa Claus Rally, it is caused by investors who sell at the end of the year for tax purposes and then buy again in January.

This causes a surge in the prices of small-cap stocks, which may lift the broader market.  It is also possible this surge is helped by year-end bonuses, some of which is invested in the market.

In the past couple of weeks, we have seen a lively rally in the stock market, courtesy of the January Effect.

  • Russell 2000 +7.5%
  • NASDAQ Composite +5.5%
  • S&P 500 Index +3.1%
  • Dow Industrials +2.6%

Year-End Bonus

For the past 25 years, I have always looked forward to year-end with my investments. First, my mutual funds would disperse their dividends and capital gains in December. Then, the stock market would seem to magically jump up a couple hundred points. By the time I tallied up my investments in January, it would add up to a pretty good year.  And, it would make up for the dog months, when the market would drop faster than I could put money in.

This year, the rally is back with a vengeance and I couldn’t be happier.  I have missed that glorious feeling of victory over the market.  And, I have missed the excitement of the ticker and the closing bell.  I know all too well the dog days will soon return.  But, for now, I pretend to dominate the market.  And, this illusion gives me comfort in a shaky financial world.

Seeing is Believing

The Santa Clause Rally has occurred in 12 of the last 15 years.  The years when Santa didn’t show up were followed by disastrous stock market collapses in 2000 and 2008.  Santa knows if you have been naughty or nice and he definitely packs some coal on his sleigh.  Whether you still believe in Santa Claus or not, the man is still relevant.  And, if you choose to write him off as a myth, you may end up taking sum lumps.

According to the NY Times, the First Five Trading Days is a reliable indicator of the coming year.  This year, we had a rally for the first five days on all of the market indices. I don’t think we should rely on history as a guide, because of the stresses in our financial system.  But, I am hoping for big gains in 2010.  And, I am keeping my fingers crossed and a candle lit.

If you Blinked, you Missed It

What most people don’t realize about the Santa Clause Rally and the January Effect, is most of the action takes place in just a couple of days.  And, it’s very easy to miss out on this windfall.  Some claim the window is from Dec 21st to January 7th.  Others claim it’s the last five trading days of December and the first two of January.  Most agree the light trading volume during the holidays helps to magnify the affect.

If you were avoiding the stock market because of the volatility, you missed a tremendous buying opportunity in 2009.  And, if you ran for cover in a CD or a money-market account, you probably received interest that was lower than the rate of inflation.  If you are parked in bonds, you should be aware that rising interest rates can devastate their market value.  So, there is no safe path for investors.  Tread wisely, as you step over the wreckage of our past.

The Bottom Line

The bottom line is, there are few things you can count on when investing.  The January Effect is a pleasant little perk that happens almost every year.  Enjoy the New Year and Santa’s little bonus from the market.

“If stock market experts were so expert, they would be buying stock, not selling advice.”

Norman Ralph Augustine – CEO of Lockheed Martin

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7 comments to How to Profit from the January Effect

  • I really wish you would have posted this article a few days before Christmas, Bret. I think the January effect has already run its course this for this year. LOL


    Len Penzo dot Com
    .-= Len Penzo´s last blog ..Your Money Horoscope =-.

    • Len,

      It was definitely a disservice to my readers, waiting until Jannury to describe How to Profit. I may have to work on my timing. Maybe, I will create a post calendar for 2010. Sorry everyone.

      Honestly, I just didn’t think of writing this post, until I proffited in the rally. And boy, did I ever profit this year. So, I got all excited and wrote this post. Hopefully, everyone who reads this will be prepared for next year’s rally.

  • Ken

    Interesting. Unbeknownst to me I benefitted. I purchased some shares last week without knowing of the January effect. You learn something every day.
    .-= Ken´s last blog ..Marriage: How to Have Healthy Money Talks =-.

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  • […] nice little investment primer on a stock market phenomenon commonly known as The January Effect and how we can profit from it.   Personally, I think this is just a futile attempt by Bret to try and “prime the […]

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