January Effect

In an already optimistic society of investors, this paper reviews an article that specifically speaks to investor optimism and psychology theory as it relates to the ‘January effect’. This effect is widely known and has been studied for many years; however, the rationale behind it is difficult to explain. Many believe that the January effect of investing is due to renewed optimism of the new year, however, there are other theories introduced that could affect the strange investor behavior in the month of January. Some of these theories introduced in the reviewed article will be analyzed and discussed in this paper.

The January effect is the phenomena that takes place every January in which the market out performs the other eleven months especially in the area of smaller stocks versus large. The knowledge of the January effect should be used as a “tool in predicting the market and other portfolios, and thus it should prove to be an important tool to portfolio managers or other managers engaged in hedging market or premium risk”, however, the pattern continues (Refuting). The two main theories most use to explain the January effect are the tax-loss theory and the window-dressing theory. The tax loss theory, as described in the article, is behavior displayed by investors by purposefully “selling their poorly performing stocks late in the calendar year to recognize capital losses and reduce their tax bill” (Investor Optimisim). This strategy also suggests that the “poor performing stocks are then repurchased in January, abnormally bidding up prices in that month” (Investor Optimism). According to Johnston and Cox, however, when adjustments are made “for size and potential tax loss selling, the abnormally high returns previously found in January are eliminated” (Tax Loss). If the January effect is the result of tax-loss selling and the awareness has become greater over the years, one would think that with this knowledge, investors would hold off until...