January Effect: A Myth or a Reality? A Delve into the World of Stock Market
Alice Blue
Tech-driven stockbroker, adept in derivatives, delivering user-friendly web & app trading solutions.
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Today, on the #TuesdayFinancialDesk, we have
What is the January Effect? Let’s listen to a story!
The stock market is a fascinating place. With its own quirks and stories, it changes its trajectory occasionally. While some of these are ruses, some exist for a reason. The January Effect is one such phenomenon observed in the stock market. Although the concept is debatable, many experts have data-backed evidence to prove its existence. Let’s analyse the data, but remember, objectivity is the key. (Just reminding!).?
The January Effect is a theory that experts developed after they saw stocks perform better in January than in other months. This phenomenon was noted year after year, and the term ‘January Effect’ was introduced. The January Effect was first reported in 1942 and continues to this day. Many factors are said to contribute to this, including tax-loss selling. Tax-loss harvesting, or tax-loss selling, is a strategic approach investors use to minimise their tax liability. By selling investments that have declined in value, investors can realise capital losses, which can be used to offset capital gains earned from other investments. Since capital losses are tax-deductible, this strategy helps to reduce the overall taxable income on an investor’s tax return.
After the selling period, oversold stocks often rebound, with share prices recovering as the market stabilises. This upward trend typically sets the stage for a healthier market environment in January. Another assumption is that holiday bonuses drive the January Effect, as traders have more money to spend.?
The data tells us that “ from 1904 to 1974, stock returns were five times higher than average during January.” Another study by Salomon Smith Barney found “an average January outperformance of 0.82% when comparing small-cap stock returns to large-cap stock returns from 1972 to 2002.”
The past and present of the January Effect
While many still support the January Effect, a few analysts predict its waning effect on the stock market. This year is a classic example in the latter direction. Even though Nifty started 2025 with exceptional gains, it came nowhere close to the gains incurred in the last decade.?
According to data from The Economic Times, “Nifty’s average return over the last 10 years is just 0.38%, and it has closed positively on only three occasions in that period. In contrast, Nifty IT’s average return during the same period stands at 2.1%.” It is predicted that with IT stocks accounting for 14% of Nifty's total weight, the sector holds the second-highest influence on the index. Their performance could be a key factor in determining Nifty's outcome for the month.
Nifty’s sluggish performance in January is attributed to the lack of solid contributions by banks, pharma, and FMCG. Data states that “in the last 10 years, Nifty Bank has finished January positively on five occasions, with its highest return of 7.2% in January. However, it recorded an 8.3% decline in 2016, its worst performance during this period. In 2024, the 12-stock index closed down by 4.8% month-on-month.” (The Economic Times).? Hmm, so where do we stand on January Effect now?
Meet the decision-makers: Factors that can shape January Effect in 2025
While the debate goes on in the background, let’s look at the few factors that could change the course of the January Effect.?
Drum roll, everyone! With Trump taking office in January and his scoop of tariff changes, a lot can change globally, and tremors will be felt in the stock market.?
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FIIs can be game-changers here. Data suggests that foreign institutional investors (FIIs) have offloaded domestic equities worth ?5,949 crore in the first two days of this year. Over the past decade, FIIs have been net sellers in January six times, with the highest outflow recorded in 2022 at ?33,303 crore.
The annual budget for the financial year 2025-26 is scheduled for February 1, 2025. A lot will change here.?It is alleged that stocks like defence, for instance, will be soaring high this quarter, which is driving increased investment.
Trader spotlight: How to invest during the January Effect?
As a trader, you can leverage the January Effect to build your wealth during the month. Here are a few ways to align your portfolio with the stock market phenomenon.?
Instead of putting all your eggs in one basket, diversify your portfolio and invest in multiple stocks from different sectors. If one industry picks up, it will cushion you against volatility in other sectors. Never forget the rule number one. The market is unpredictable!
Experts recommend investing in small and mid-cap stocks during the January Effect. They often witness a surge in these stocks during this period compared to other large-cap stocks. However, significant risk is involved, so invest if it aligns with your risk tolerance.?
Always remember that these anomalies can change over time. Stay objective, research, and make informed decisions. Do not let emotions override your financial decisions.?
Conclusion
The January Effect is still being debated in the financial industry. However, remember that the stock market involves significant risks, and investing wisely and objectively is essential to achieving profit.
Thank you for reading. Leave your thoughts and questions in the comments. We love reading all of them. Stay tuned for the next Financial Mail.?
Alice Blue does not endorse any of the stocks mentioned above. The information provided is for educational purposes only.