Three Ways to Play the January Effect

History tells us there's often a major disconnect between technicals and sentiment in late December and market action in early January. End-of-year window dressing, light holiday volume and retail tax selling all combine at this time of year to yield unique market dynamics that tend to go "poof" once the calendar flips into January.

Predictions for 2010: China, Dollar, Dow By Eric Jackson Looking Back at New Years Past By Dick Arms

You've probably noticed that the strongest stocks of 2009 have gotten even stronger in the last two weeks. This resiliency makes sense -- investors don't want to sell their biggest winners so close to year-end and get hit with capital gains tax. So they wait until the start of January, when the prior year's leadership often gets dumped aggressively.

On the flip side, many of this year's biggest losers could attract aggressive buyers in January, because risk appetite is expected to grow exponentially with 12 new months on the calendar to turn an annual profit. This positive seasonality contributes to the classic January Effect, which favors small-cap and underdog performance.

As we pass through the door into 2010, keep in mind that trading strategies based on December momentum usually turn out to be unprofitable, and even dangerous. A better approach is to capitalize on the expected dynamics of a shiny new market year. In that regard, here are three swing trades that take advantage of typical January seasonality.