Tax Loss Selling vs. the January Effect

We’ve had the kind of year where small caps could see a nice rebound in January. This so-called January Effect, goes one theory, is tied to tax-loss selling at the end of the foregoing year. The selling dampens prices for underperforming stocks at year’s end and results in a January bounce as many of the tax-loss investors re-enter their positions. The pattern tends to be more pronounced in small caps because they are less liquid.

On average, says the Stock Trader’s Almanac for 2009, buying stocks trading at 52-week lows in the week before Christmas and holding them for a 4- to 6-week period has generated average gains of 13% since 1974, versus 3.4% in the market. This “Free Lunch” strategy performs best, says the Almanac, after market corrections and when there are a lot of new lows. That would seem to fit the description for 2008.

In the interests of disclosure, I should mention that I purchased a small-cap exchange-traded fund in November (iShares CDN Small Cap Index Fund). It’s intended as a long-term investment, but a nice uptick in January would help improve the morale.

By the way, for anyone still contemplating tax-loss selling, there is some academic research that suggests it may be better to do it in January, believe it or not. Apparently, you would be further ahead because the price gain from the January effect would on average offset the lower tax-loss claim.

Comments

[Steven Hansen:]

Larry, there might be some investors needing december tax loss write-off but is suspect it might be less than other years. How do you order this almanac?

2008 Dec 07 05:11 AM

[NOWHEREMAN:]

The biggest problem with Indicators which become Popular is that everyone knows about them.

Tax loss selling could be counted on in early December and one could look at the new lows in Barron's to see what might be interesting for an early Jan. pop. And then people started selling earlier.

Ditto with October massacres, you had September selloffs in anticipation of the massacre which did not materialze.

I used to be able to pick up a copy in a Walgreens in Downtown Chicago but that was probably because of its proximity to the Board of Trade building. I would think that a large bookstore would carry it, Magazine section probably not far from the Farmer's Almanac.

I used to use the Farmer's Almanac for Ag and Oil trades. They can be very uncanny regarding weather conditions. Very Cold weather outlook for Midwest and Northeast will do wonders for your wallet, especially if you read about it in October. IMHO

2008 Dec 08 02:19 AM

[RCA:]

On Dec 08 02:19 AM paultaut wrote:

> The biggest problem with Indicators which become Popular is that
> everyone knows about them.

Exactly right! The Internet, rather than leveling the playing field for the common man, has given individuals an illusion of being an insider with privileged information. The new "informed" investor is discovering (again), at a faster pace, the tyranny of the herd.

2008 Dec 08 10:24 AM

[Orlando Ste...:]

What about some beaten down, low price January Effect stocks?

I'm long on CY and it's working up nicely, Any others?

2008 Dec 12 09:17 PM