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What Is the January Effect?

Jan. 8, 2013
3 mins
A woman on an airplane uses her computer during flight

Among investment circles, it’s a well known fact that the stock market generally sees an upswing in the month of January. It’s a somewhat reliable trend that can allow investors to make money, if they play it right. But should you take advantage of this phenomenon, known as the "January Effect"?

How you can make money

Simply, buy when the market is somewhat lower in December and sell of your stocks during the higher flying days of January to bring in a profit. Again, since the trend impacts smaller companies, not the big Fortune 500, focus your investment strategies on many small players.

Why it happens

The theory is that some investors sell off stock at the end of the year for tax purposes — that’s why this is also called tax loss harvesting. They buy it up again in January, adding to the activity and the prices in the market. The upswing tends to impact mostly small and medium sized companies selling on the stock market.

What's the catch?

The big problem with this approach is you don’t know if it’s going to work until the project is in full swing. Some experts say the trend has been less pronounced in recent years because more people are using sheltered retirement savings products, both in Canada and the U.S. But a huge event: such as a natural disaster in a powerful country or another event that impacts the economy could easily wipe away these small gains.

This year's market activity

So far, markets this January are playing by the rules. Thanks to good job news in both Canada and the U.S., North American markets were up in the first week of trading for the month. But it's early days, as they say.

The recently averted fiscal cliff is causing some investment experts to theorize on its effects on the market. Some are saying that the effect will be big this year as wealthy U.S. investors sold off at the end of 2012 to avoid possible tax hikes in the new year.

Meanwhile, since the crisis has been averted, critics are now worried about the huge U.S. deficit and ongoing concerns about another recession, which could impact the market.

If you want to try to ride this interesting annual phenomenon, do your own research, talk to an advisor and  see if it makes sense to try if not this year, then maybe next.

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