The January Effect and Other Seasonal Stock Market Patterns – TrendSpider Blog

Market technicians use statistics to identify patterns and predict future price movements. While technical indicators are the most popular example of these statistics, technical analysts also examine prices on a longer timeframe to try and identify seasonal stock market patterns.

In this article, we will look at three popular seasonal stock market patterns, examine whether they are still accurate predictors, and discuss how to use them to your advantage when trading.

The January Effect

Sydney Wachtel coined the term January Effect in his 1942 paper, “Certain Observations on Seasonal Movements in Stock Prices”, where he found that small-cap stocks outperformed the market in the month of January between 1925 and 1942.

More recent studies have confirmed the effect when averaging performance into the 2000s. In The Incredible January Effect, Haugen and Lakonishok found that the market performed much better in the month of January than any other month between 1927 and 2001.

Source: The Incredible January Effect

There are several possible reasons for the effect:

  1. Tax Loss Harvesting: Many investors sell their losing stock positions in December to realize the losses and offset their tax bill for the year. The downward pressure in December leads to potential discounts in January.
  2. Portfolio Rebalancing: Many investors rebalance their portfolio at the end of the year to maintain their target asset allocations. The downward pressure on outperforming stocks in December could also lead to January discounts.
  3. Holiday Bonuses: Many people receive bonuses from their employers during the holiday season and may invest that capital into the stock market in January. The increase in buying pressure could boost stocks in January.
  4. New Year Resolutions: Some people may resolve to invest in the stock market starting in the new year, which could create buying pressure in January.

These trends are most pronounced in small-cap stocks since mid- and large-cap stocks are generally more liquid and efficient in adjusting for any temporary fluctuations.

Critics argue that the January Effect is becoming less pronounced over time as algorithmic trading leads to a more efficient market. The effect may become so small that the transactional costs needed to exploit it could make the strategy unprofitable for retail traders and investors.

Sell in May & Go Away

Old English stock brokers coined the phrase, “Sell in May and go away, do not return until St. Leger’s Day” more than a century ago. Since then, the adage has been shortened to “Sell in May and go away” or may be referred to as “The Halloween Indicator” given its October end point.

In 2012, University of Miami professors Sandro Andrade and Vidhi Chhaochharia found that stock returns were ten percent higher between November and April compared to the period between May and October. The study encompassed 37 different markets across a 14 year timeframe, meaning that the tendency to underperform in the summer may be a global phenomena.

Bloomberg analysts found similar trends when analyzing monthly returns for the S&P 500 between 1988 and 2011:

Source: Bloomberg

The most common reason given for underperformance during the summer months is the lack of liquidity compared to winter months. Many traders and investors go on vacation in the summer, which limits buying (and selling). When they return, they may be more eager to deploy capital into the market.

Critics argue that studies on this effect use small sample sizes and small time variations in expected stock market returns, which makes it an unreliable predictor of future stock market prices.

Santa Claus Rally

The Santa Claus Rally refers to the tendency of stock prices to increase between Christmas (December 25) and New Years Day (January 1). According to The Stock Traders Almanac, the effect yielded positive returns in 34 of 45 holiday seasons between 1969 and 2017.

There are several potential reasons for the effect:

  1. General Optimism: Most people are happier during the holiday period, which makes them more likely to take a bullish stance on the market. In addition, they may be eager to deploy their holiday bonuses in the market before they go back to work.
  2. Wall Street Vacations: Many institutional traders and investors go on vacation during the holiday period, which means that retail trading tends to dominate performance. Retail traders may be more bullish and less rational during this period.

Critics argue that the effect isn’t always consistent, and if a rally doesn’t occur, it could be the sign of a bear market.

Using the Effects

Long-term investors (such as retirement investors) don’t benefit very much from these effects because they are forced to pay short-term capital gains tax on any realized profits. The cost of these taxes and other transactional costs can offset a large part of the potential gains from moving in and out of the market.

On the other hand, short-term traders can benefit from these trends because they are already paying short-term taxes. Short-term traders often maintain a bullish bias during the Santa Claus Rally period and into the January Effect period, while taking a bearish bias during the summer months.

The Bottom Line

There’s little doubt that seasonal stock market patterns have existed throughout history, but past performance is no guarantee of future performance. The rise of algorithmic trading has made markets more efficient and many of these effects may already be priced into the market.

That said, short-term traders may want to use these seasonal stock market trends to help guide their trading by taking a bullish or bearish bias.

TrendSpider Recent Fixes and Additions In Early January

At TrendSpider, we are constantly working on adding new, useful features to our platform as well as updating and improving the ones we currently have. In this blog post, we look at fixes to a few features and a few additions to our indicators list. To get the full list of changes in early January, please continue reading.

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Sunday Update Week of January 7th – A Volatile Start to 2019

A prepared trader is a generally a profitable trader, and Sunday is a great day to get ready for the week ahead by studying up from last week’s price action.  In this weekend’s analysis, we take a look at the broad markets after the first moves into 2019. After a rather sluggish start, Friday proved that there are some bulls still left in the equation. Will the bullish momentum continue into the rest of the month of January? Check out the charts in this blog to see how they look!

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What is a Hammer?

Technical analysis has been used since the 1900s to predict stock market prices. Unlike fundamental analysis, market technicians believe that all available information is already reflected in a stock price, and day-to-day market fluctuations are more a function of human emotion (fear and green) than changes in the underlying value of a company.

Candlestick charts have become especially popular among market technicians because they provide quick insights into market psychology. A candlestick shows the open and close as a candle (or real body) and the high and low as a wick (or shadow). The differences between the open, high, low, and close provides keen insights into market sentiment.

For example, a small candle with long wicks suggest that the period was characterized by a lot of indecision in the market. Traders may want to exercise caution since there’s no clear direction. On the other hand, a large candle with short wicks suggests that the stock moved strongly higher or lower, and a longer term trend may soon emerge.

Let’s take a look at one of the most frequent and popular candlesticks used to predict bullish reversals—the Hammer.

The Hammer Pattern

The Hammer is a popular candlestick pattern that, not surprisingly, resembles a hammer. That is, the candle is relatively short (e.g. the hammer’s head), the top wick is very short or non-existent, and the bottom wick is relatively long (e.g. the hammer’s handle). The bottom wick is typically at least two or three times the height of the candle.

There are four different ways to interpret Hammer candlestick patterns depending on their orientation (standard or inverted) and position within the larger trend.

Bullish Hammer & Hanging Man

The Bullish Hammer is a bullish reversal pattern that follows a downtrend. The lower wick indicates a struggle between bulls and bears for control over the price, while the candle’s positive close shows that the bulls ultimately won the fight. In addition to predicting reversals, bullish hammers can also indicate important support levels.

The Hanging Man looks similar to a Bullish Hammer, but the candle has a negative close and the pattern follows an uptrend rather than a downtrend. In this case, the lower wick suggests that bears are becoming increasingly confident in a reversal, while the small bearish candle suggests that bears are starting to win the fight.

Inverted Hammer & Shooting Star

The Inverted Hammer, not surprisingly, looks like the Bullish Hammer, but it’s upside-down. Like the Bullish Hammer, the bullish reversal pattern appears following a downtrend. The long upper wick suggests a lot of indecision in the market, but the positive close shows that bulls may have managed to gain the upper hand.

The Shooting Star is a bearish reversal pattern that looks similar to the Inverted Hammer, but it appears following an uptrend and the candle has a negative close. The long upper wick indicates that the price gapped higher, but the failure of the bulls to remain in control throughout the period suggests that there could be a change in trend ahead.

How to Trade a Hammer

The Hammer candlestick patterns are relatively common and fairly accurate in predicting reversals. According to Bulkowski’s research, the Hammer is in the top third percentile in terms of frequency and correctly predicts a bullish reversal 60 percent of the time.

In reality, candlestick performance depends largely on the individual security. Hammer patterns may be much more accurate predictors of reversals in some securities, and not so great predictors in others. You should experiment with the Hammer and other candlestick patterns to see what works best for a given security, timeframe, and situation.

As with all candlestick patterns, Hammer patterns work best when combined with other forms of technical analysis that act as confirmation. The Hammer’s long wick suggests that plenty of indecision remains in the market, and it’s important to watch subsequent candlesticks and consider the wider trend to confirm a reversal before placing a trade.

TrendSpider makes it easy to find Hammer patterns using automated pattern recognition, as well as see important trend lines across timeframes.

Let’s take a look at an S&P 500 ETF (SPY) chart:

In this chart, TrendSpider identified a Shooting Star on November 9th. The following candle shows a strong move lower that confirmed the change in trend. An Inverted Hammer marked the end of the downtrend on November 23rd, and the price rose to form a bearish double top chart pattern. The index then experienced a significant decline.

The Bottom Line

Candlestick charts are a great way to gauge market psychology at-a-glance. While they don’t generate surefire signals on their own, they are great leading indicators for potential reversals that can be confirmed with other forms of technical analysis.

TrendSpider makes it easy to spot Hammers and other candlestick patterns. Sign up for a free trial and see how you can improve your trading with automated pattern recognition.

TrendSpider Thursday Analysis – A Rocky Start to 2019

Thursday’s are a great day to observe how the final day of the week may close out by looking at the daily and weekly candle setup into Friday. As the markets have started 2019 with everything but a “bang”, more downside looks to be possible based on the current setup that has returned big downside within the current price channels.

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