All posts by neville

Backtesting the “January effect” theory

If you trade stocks you have no doubt heard of the January effect. It goes something like this:

“The stock market for the year does the same that it does in January. If the month of January is up, then stocks will be up for the full year. If the month of January is down, then stocks will be down for the full year. Furthermore, the 1st trading day in January is a predictor for the month of January and thereby a predictor for the full year”

Well, I thought it would be a good exercise to start the year by testing this theory,  As good as last year’s 30% gains were, I sure would not want to go through 30% losses this year :(

Specifically I wanted to test the 1st day theory and test it with the NASDAQ index.  Most of my mutual fund holdings today are in QQQ or TQQQ – which is the NASDAQ 100 ETF.

I wanted to go back through at least my lifetime (from 1980 on), since I remember the NASDAQ even back then was talked about as the “tech index”.  Here are the numbers. Two rows for each year, which show the NASDAQ close on 31 Dec and 2 Jan for each year:

year    NASDAQ closing price         Adj Close    Percentage Gain for year    Percentage Gain for 1st trading day of year    Verdict on Swami…
31-Dec-80        202.34
2-Jan-81        203.55
1981    31-Dec-81        195.84    -4%    0.60%    Incorrect Positive Prediction
4-Jan-82        195.53
1982    31-Dec-82        232.41    19%    -0.16%    Incorrect Negative Prediction
3-Jan-83        230.59
1983    30-Dec-83        278.6    21%    -0.78%    Incorrect Negative Prediction
3-Jan-84        277.63
1984    31-Dec-84        247.1    -11%    -0.35%    Correct Negative Prediction
2-Jan-85        245.9
1985    31-Dec-85        324.9    32%    -0.49%    Incorrect Negative Prediction
2-Jan-86        325
1986    31-Dec-86        348.8    7%    0.03%    Correct Positive Prediction
2-Jan-87        353.2
1987    31-Dec-87        330.5    -6%    1.26%    Incorrect Positive Prediction
4-Jan-88        338.5
1988    30-Dec-88        381.4    13%    2.42%    Correct Positive Prediction
3-Jan-89        378.6
1989    29-Dec-89        454.8    20%    -0.73%    Incorrect Negative Prediction
2-Jan-90        459.3
1990    31-Dec-90        373.8    -19%    0.99%    Incorrect Positive Prediction
2-Jan-91        372.2
1991    31-Dec-91        586.34    58%    -0.43%    Incorrect Negative Prediction
2-Jan-92        586.45
1992    31-Dec-92        676.95    15%    0.02%    Correct Positive Prediction
4-Jan-93        671.8
1993    31-Dec-93        776.8    16%    -0.76%    Incorrect Negative Prediction
3-Jan-94        770.76
1994    30-Dec-94        751.96    -2%    -0.78%    Correct Negative Prediction
3-Jan-95        743.58
1995    29-Dec-95        1,052.13    41%    -1.11%    Incorrect Negative Prediction
2-Jan-96        1,058.65
1996    31-Dec-96        1,291.03    22%    0.62%    Correct Positive Prediction
2-Jan-97        1,280.70
1997    31-Dec-97        1,570.35    23%    -0.80%    Incorrect Negative Prediction
2-Jan-98        1,581.53
1998    31-Dec-98        2,192.69    39%    0.71%    Correct Positive Prediction
4-Jan-99        2,208.05
1999    31-Dec-99        4,069.31    84%    0.70%    Correct Positive Prediction
3-Jan-00        4,131.15
2000    29-Dec-00        2,470.52    -40%    1.52%    Incorrect Positive Prediction
2-Jan-01        2,291.86
2001    31-Dec-01        1,950.40    -15%    -7.23%    Correct Negative Prediction
2-Jan-02        1,979.25
2002    31-Dec-02        1,335.51    -33%    1.48%    Incorrect Positive Prediction
2-Jan-03        1,384.85
2003    31-Dec-03        2,003.37    45%    3.69%    Correct Positive Prediction
2-Jan-04        2,006.68
2004    31-Dec-04        2,175.44    8%    0.17%    Correct Positive Prediction
3-Jan-05        2,152.15
2005    30-Dec-05        2,205.32    2%    -1.07%    Incorrect Negative Prediction
3-Jan-06        2,243.74
2006    29-Dec-06        2,415.29    8%    1.74%    Correct Positive Prediction
3-Jan-07        2,423.16
2007    31-Dec-07        2,652.28    9%    0.33%    Correct Positive Prediction
2-Jan-08        2,609.63
2008    31-Dec-08        1,577.03    -40%    -1.61%    Correct Negative Prediction
2-Jan-09        1,632.21
2009    31-Dec-09        2,269.15    39%    3.50%    Correct Positive Prediction
4-Jan-10        2,308.42
2010    31-Dec-10        2,652.87    15%    1.73%    Correct Positive Prediction
3-Jan-11        2,691.52
2011    30-Dec-11        2,605.15    -3%    1.46%    Incorrect Positive Prediction
3-Jan-12        2,648.72
2012    31-Dec-12        3,019.51    14%    1.67%    Correct Positive Prediction
2-Jan-13        3,112.26
2013    31-Dec-13        4,176.59    34%    3.07%    Correct Positive Prediction
2-Jan-14        4,143.07
2014                ???    -0.80%

All total that’s 33 years.

23 up years and 10 down years (up 70% of the years)

14 correct positive predictions
4 correct negative predictions
6 Incorrect Positive Predictions
9 Incorrect Negative Predictions
In total, that 18 correct predictions and 15 incorrect predictions  (55%)

Some interesting things fall out of this table.  For instance, do you remember that Jan 2 2001 was down -7.23% for the 1st trading day of January! Whew!

At first glance you may say that something that predicts with 50+% accuracy is a good predictor. That is not correct. You have to remember the stock market is not a random coin flip (where 55% prediction accuracy would be great!) but something that tends to rise over time. So a predictor that says “Any year beginning with the digit 1 or 2 will be an up year” would be right 70% of the time. In that light, I’d need a January effect predictor that would need to be something much more accurate than 70% for me to be interested.

More interesting still, if trying to use the data to your trading advantage.

If you bought the NASDAQ on Jan 2, 1980 and held it to Dec 31, 2013- your gain would be 1952% (4176-203)/203.   If instead you watched the 1st trading day of Jan and went 100% in the market in years where that 1st trading day was up and stayed out of the market for the whole year when the 1st day was down, you would have a 33 year total return of 1945%, virtually identical to buy and hold.

Therefore, in proper Mythbuster’s fashion, the 1st trading day of January theory is *BUSTED*