What is the January effect in the stock market?

The January effect explained: History and definition

The January effect is the hypothesis that share prices tend to rise in early-to-mid January compared to other times of the year. This pattern is particularly noted among smaller companies (known as small-cap stocks).

The history of the January effect dates back to 1942 when investment banker Sidney B. Wachtel analysed market data from 1925 onward. He discovered that smaller companies tended to outperform larger corporations (large-cap stocks) during the first few weeks of January^1.

Since then, numerous studies have examined this pattern with varying results². Most research suggests that when the effect does occur, it's primarily visible in smaller companies rather than well-established large corporations. This makes sense as smaller companies' share prices can move more dramatically with relatively modest buying activity.

Is the January effect real? Evidence and analysis

The reality of the January effect depends on who you ask. Some traders see clear evidence of the pattern, while others view it as nothing more than a self-fulfilling prophecy.

The historical evidence is mixed:

• Early studies (1925-1985): Data showed January was often the best-performing month, particularly for smaller companies (looking at historical price movements and charts)³
  
• Recent decades (1995-2023): The effect appears to have weakened significantly⁴

This seasonal market anomaly, like other calendar effects in stocks, has been the subject of extensive research in market seasonality patterns.

According to research published by Nicholas Moller and Shlomo Zilca in 2006, the phenomenon is most apparent in the first half of January but typically reverses in the second half of the month⁵.

Further analysis by U.S. Global Investors combined with Bloomberg data reveals an interesting shift: From 1964-1994, January was typically the best-performing month for both the S&P 500 and Russell 2000 indices. However, in the following 30 years (1995-2023), January dropped to eighth place among monthly performance rankings⁶.

Market data through 2024 has continued to show the diminishing predictability of the January effect, though analysts continue to monitor this pattern in 2025 trading.

If you're considering trading based on the January effect, remember that solid investment decisions typically combine:

• Pattern analysis (looking at historical price movements and charts)
• Company fundamentals (examining business performance, industry trends, and financial health)
• Risk management (strategies to protect your capital if markets move against your expectations)

In other words, don't base your entire trading strategy on the January effect alone. The evidence suggests its influence has diminished considerably over recent decades.

What causes the January effect? Key factors explained

Several factors may contribute to the January effect when it does appear.

Tax-loss harvesting

Investors often sell underperforming shares in December to create capital losses that reduce their tax bills. They then repurchase those same shares in January. Because smaller companies' shares typically have lower trading volumes (less liquidity), this selling and buying pattern can cause more significant price movements.

Year-end bonus investments

Many people receive annual bonuses in December or January and choose to invest this money in the stock market, potentially driving prices higher.

Investor psychology

The "new year, new beginnings" mindset might prompt individuals to start investing as part of their New Year's resolutions. Additionally, as more investors learn about the January effect, they might buy stocks in anticipation of it, creating a self-fulfilling prophecy.

How to trade seasonal trading patterns with IG

You can use CFDs to trade seasonal trading patterns with IG:

1. Create a live account
2. Research which stocks you want to trade
3. Do technical and fundamental analysis
4. Open positions according to your analysis
5. Closely monitor your trades

Key points to remember

• Small-cap stocks historically rise in early January
• Effect has weakened significantly since the 1990s
• Caused by tax-loss selling, bonuses, and psychology
• Primarily occurs in first half of January
• Best used as part of a broader trading strategy, not in isolation

Footnotes:

¹ Investopedia, 2024.
² The Motley Fool, 2024.
³ ScienceDirect, 1983.
⁴ Evidence Investor, 2024.
⁵ ResearchGate, 2008.
⁶ U.S. Global Investors, 2024.