In previous articles, we have looked at certain months to stay out of the market but are there any which you should be in and does this affect any other market such as Forex.
The January effect is basically a term to describe the rise in price over the first month of the year or the reverse in price in February. If this is the case it means two things can be done.
If the price rises, then you would be able to buy stocks at the beginning or January and sell at the end with a slight statistical advantage.
If there is a reversal in price after the first month, then if the market goes up you sell at the end and vice versa.
Although these terms are known for the US stock market, could this also have an effect on other tradable securities such as the USD? If the US stock market affects the USD and the USD can cause disruption in the forex market, it must be said there is a January effect in the forex market as well.
Do US Stocks Perform Well in January?
When looking at this you do not want to look to see if January on Average is a profitable month but is it more profitable compared to months. This is due to stock markets on average having a long bias so you will want to compare it to the average performance of other months to see if you have a statistical advantage. Looking back over the S&P 500 since 1950 the average rise in the price is around 1.79% (we use long time frames as the larger the data sample, the more accurate the prediction is). When we look at all months combined to find the average rise of any month it works out to only 0.65% rise. These two figures clearly show that the rise in price can be 3 times what it would in normal months offering a large statistical advantage. This can be used as a trading strategy in itself for only for a short period for each year but can be included in a portfolio of activities
Does the January Effect change the development for the rest of the year?
To find the answer to this question we must look at correlation coefficient between the performance over January compared to the performance for the rest of the year. When we look at the stats you are looking at a 0.25 coefficient which is much stronger than if you take any other month to compare it to the rest of the year performance of around 0.016, which leads to the saying on Wall Street that ‘As January goes, the rest of the year goes.
If we apply this to 2016 from January 4th when the market opened till the end of January, the price went from 2033 down to 1928 which is just under a 10% decline. Since then the market has bounced back up to 2094 which is around a 15% rise. So does this fly in the face of our theory or does it lead you to think that the market is overvalued and will drop back down before the end of the year?
Can we use this to predict the USD?
We can then do a similar calculation by examining the USD dollar index for Januarys and comparing the performance against other months. From 1950 we have a roughly 0.49% increase in the index on average. This confirms the there is also an average rise in the USD index although this is to a lesser extent than the S&P.
Does January affect the rest of the year for the USD ?
To measure this, we have to look at the coefficient of the January performance and the performance for the rest of the year. When measuring we get a correlation coefficient of 0.18, which is a strong number. But when we compare it to the correlation coefficient of the rest of the year it is 0.12, which is far stronger than the correlation to the S&P.
Both the USD and the S&P index have shown a strong bias towards the January Effect over the past 60 years but it is obvious that this process can be utilized more effectively on indexes than the USD. What could be seen more interestingly, is during the month of January both the USD and S&P tend to rise in value.