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Tuesday, February 3, 2009

January Barometer

According to Investopedia, the January Barometer is "A theory stating that the movement of the S&P 500 during the month of January sets the stock market’s direction for the year (as measured by the S&P 500). The January Barometer states that if the S&P 500 was up at the end of January compared to the beginning of the month, proponents would expect the stock market to rise during the rest of the year. " - http://www.investopedia.com/terms/j/januarybarometer.asp

Personally, I'm not a fan. I think it's a theory that the mass (i.e. generally ignorant public) can be easily duped with figures, but the reality is that it's not that simple, and probably does more harm than good if followed blindly. Just take a look at the table below:

At first glance, it seems to work - there are more years where the full year's returns are the same direction as January returns.

But a closer examination shows that there are at least 3 problems -- there may be more.

First, the full year returns include January returns. To be a predictor, it needs to separate out January, from the rest of the other 11 months (Feb to Dec), so, strictly speaking, January return should be EXCLUDED. So, in the table above, if January is down, it doesn't mean that the rest of the year is down. In fact, as shown below, in 6 out of 7 times that January is down, the next 11 months is actually UP! *grin*

Second, it doesn't work equally well when January is up versus when January is down. I leave this to you to study the table in detail, and to not blindly accept what Investopedia and any other newspaper columnist says about the January Barometer.

Consider the following years when January is negative.
- 1990 - Jan -5.9%, Year -4.3%, i.e. the rest of the year is actually positive!
- 1998 - Jan -0.02%, Year +16%, i.e. the rest of the year is actually positive!
- 2000 - same pattern - rest of the year is actually positive.
- 2002 - same pattern
- 2003 - same pattern
- 2005 - same pattern
- 2008 - this is the only year where the January Barometer actually works when January is a negative month!!!

In other words, when January is negative, history says that the rest of the year (i.e. the other 11 months) is 6 out of 7 times the OPPOSITE.

Third, such comparisons are far too simplistic, and ignores the high and lows that occurs DURING the year. For example, in 2008 --- yes, January 2008 was a negative month. Yes, entire 2008 was a negative year, and hugely negative too. But the S&P itself went up from March to May 2008. In other words, this January Barometer is far too simplistic to be of any use to the serious trader.

So, treat the January Barometer as something interesting for mass consumption, but don't let it influence your trades unnecessarily.

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