The term January effect is used to describe a historical trend, whereby the prices of securities rise in the month of January. The January effect is classified as a secondary trend, since it is relatively short in duration.
Financial markets, such as commodities, bonds, and stocks, typically demonstrate an upward or downward trend over time. The January effect is a secondary trend, which manifests itself as the largest monthly increase in a financial market, or an individual security, for the remainder of the current calendar year.
The January effect is thought to be the result of two factors:
- An increase in the purchase of securities following a sell off in the month of December, as investors lock in capital gains or losses to be reported on their federal income tax returns.
- The payment of yearend bonuses to employees, which subsequently invest this money in the stock market.
Since individual investors are more likely to purchase small cap stocks, the January effect is thought to affect these securities more than mid and large cap stocks.