The 'January Effect'—Is It Real?

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It's January, so you're probably seeing lots of media headlines mentioning the 'January Effect.' But what is it, and is it real?

The theory postulates that every December stock prices fall and every January they rise, essentially driven by selling during December and buying during January.

Many believe the so-called 'January Effect' is driven by investors' tax planning. In other words, investors sell off stocks at a loss before the end of each year to try and mitigate their upcoming capital gains taxes. Once the calendar rolls over, they buy those stocks back to hold for another year of (hopeful) gains.

They do this because investors are taxed on their collective capital gains over the course of every year, measured from Jan. 1 to Dec. 31.

All this said, the January Effect is highly debated. Calendar-based fluctuations are a sign of an inefficient market, meaning people sell or buy stocks based on external concerns rather than the value of the underlying company.

Some market theorists argue that modern markets work too efficiently for the January Effect to significantly impact trading. Investors would anticipate this effect and would buy stocks as other investors offloaded them in December, anticipating the rise in January.

The truth seems to be somewhere in the middle. The January Effect no longer appears as pronounced as it was in the mid-20th century, when it was written about. However, some data still supports the idea of a December/January fluctuation.