The JANUARY EFFECT Scores Gains In January
Today I’m examining a trading strategy called the “January Effect“. This trading strategy is aptly named because it’s designed to be traded only in the month of January. I’ve run the numbers and now it’s time to reveal if this trading strategy is a money maker or a money burner.
Wall Street has maintained that stocks rise in January. As such, going long with a buy and hold approach is the way to trade the January Effect.
A general increase in stock prices during the month of January. This rally is generally attributed to an increase in buying, which follows the drop in price that typically happens in December when investors, seeking to create tax losses to offset capital gains, prompt a sell-off.
Typically this involves small-caps, like the stocks on the Russell 2000. If you look at the chart below comparing the S&P 500 with the Russell 2000, you will see that for the first 9 months of 2015, small-caps dominated. Then on September 28, 2015, the big-caps started performing better as investors cashed in small-cap holdings. The January Effect seems to be working as described. But will the January Effect show gains in January?
How Effective Is The January Effect?
This one is easy to test. I went back nine years (want something current but enough years to get a good idea how it works in today’s electronic trading age) and crunched the numbers. If you take a look at the chart below, you will see I have documented the returns of the S&P 500 and the Russell 2000.
As you can see, the premise behind this strategy is flawed. On average, stocks don’t rise in January. The results over the last nine years show both small-cap and big-cap stocks go down in January.
How To Trade The January Effect
OK, so the strategy is a money burner. Here’s how we can turn this money burner into a money maker. Now that we know stocks usually drop in January, let’s cash in on this information. All we need do is buy and hold a Contra-etf such as TZA or SPXU.
As you can see in the chart above, just buying and holding TZA earns us an average 3.75% per month in January. Not bad for a losing month in the stock market.
The returns of TZA are impressive in January. Anyone can buy and hold this ETF, perfect for beginner or pro alike. It’s simple to implement.
One word of caution. You can see there are two years with big losses. If you trade this, be prepared and willing to accept a 25% chance of suffering a big loss. To be the most effective, you need to trade the strategy every January for many years to come (unless you get lucky the first year).
I do want to mention, I’ve also compared the returns of my proprietary Index Trading System. If you don’t mind doing two trades in the month of January instead of one, my trading system offers additional benefits.
If we look at the returns you can see it is only slightly better than buying and holding TZA. So why make the extra trade? For one, there is a 44% chance you will make a double-digit gain. In fact all winners have been double-digits. When you look at the losers, there is only one big loser instead of two. The chances of hitting a big loser are less.
The above are good points to consider if you plan to trade it only one or two times. However, if you plan to trade it for many years to come, then buying and holding TZA may be your best bet as it is easier to implement.