When picking which stocks to buy, traders and investors sometimes look to market trends to time their buying and selling on a daily, weekly, monthly, quarterly, and yearly basis. The year end sell off, and then subsequent spike in prices in January, is one of the cyclic timers that may provide a good entry point. For some traders, it is a such a regular and predictable event that they load up during this period.
What is the "January Effect"?
The tax code in the US provides the catalyst for what has been dubbed the January Effect. For investors and traders that have held both winning and losing stocks, the tax burden can be onerous. For the winners, taxes as high as 40% can be levied against investments held less than a year. In order to offset those taxes, investors can sell their losses and use those losses to counter the tax burden of the winners. In the end, the investor know he has lost, and by cutting his losses, can increase how much of his winners he keeps. This can translate into the some of the biggest losers for the year seeing a further dive as there is an increase in a selloff in late November and December.
The downward pressure put on in November and December many times translates into a company being oversold and the price pushed down below what the market really believes it is valued at. After the new year, the oversold condition can begin to correct as the stock begins to shoot back up to a fair market value. For those investors who can recognize the oversold condition, the cyclic timing can be very profitable.
While this has been true historically, the last decade seemed to buck the trend overall. While the S&P may not have continued the trend, there are still opportunities with individual companies and stocks.
Profiting from the "January Effect"
Traders can profit from the January Effect with either short positions or long positions that are timed to take advantage of either a further fall or are ready to rebound.
When looking for the right stocks, not all are created equal. Stocks that have seen a decline over the course of the year can be prime targets for investors and traders that may look to dump them at year end.
Research has also noted that Small Cap and Value stocks have seen stronger correlation for the January Effect.
For those looking to take a short position, now is the time to identify and target those companies that will see a year end tax sell off. While some may think the bottom is already here, investors selling off may drive the price down even further.
For those looking to buy into weakness, identifying the companies now and monitoring them into late November and December will provide buying opportunities. As they become oversold at the end of the year, traders and investors should see a pop in mid to late January.
This is the beginning of a series of articles I will look at, trying to identify which companies are poised for a "January Effect". Some are highly controversial with Bears and Bulls lining up on each side. The intent isn't to create a Bear or Bull thesis for investing in these companies, but to identify opportunities from market weaknesses and oversold situations.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.