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The January effect describes the tendency for small cap stocks to outperform large cap stocks during the month of January.

This is a well known anomaly that has been discussed in numerous journals and research papers going back as far as 1942 by Sidney Wachtel.

Another study, by Rozeff and Kinney, looked at data between 1904-1974 and found that market returns were as much as five times greater in January than any other month.

Numerous studies have been done since then with differing opinions over the effectiveness of the strategy in recent times.

Some academics suggest that the effect has dwindled in recent years as more investors have become aware of the anomaly.

Others (such as Ziemba) suggest the anomaly has simply moved to December.

As more people become aware of a market anomaly it’s logical that more investors try to anticipate the trade and it either shifts to an earlier time or is arbitraged out.

Explanation

Possible explanations for this anomaly are tax loss harvesting, window dressing (accounting) and investor psychology.

stock market anomalies january effect

Strategy:

You can capitalize on this anomaly by going long a basket of small cap stocks and simultaneously shorting a basket of large cap stocks during the month of January.

This can be achieved with E-Mini futures or ETFs. You may want to initiate the trade at the end of December as the effect seem to gets earlier and earlier each year.

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