My Take on the Jan Effect

Discussion in 'Strategy Development' started by Babak, Jan 6, 2003.

  1. Babak

    Babak

    I'm sure everyone is familiar with the "January Effect" -- a phenomena that takes stocks higher at year end. There have been many studies done to show that it is real and it has become very well accepted by the general trader/investor community.

    Although I play the January effect, my take on it is a bit different. And as I promised in a previous thread["Jan Effect"], I would like to share it with the members of ET. Consider this a very tiny, tiny way I can give back to the many folks here that make it a great place.

    As many things in life, the January effect is really in the eye of the beholder. By that I mean it depends who is talking and what they are looking at. Some say the general market (large proxies like Dow, Nasdaq, etc.), while others say the small caps (Russell 2000). I define the January effect as the once in a year event when the baby gets thrown out with the bathwater.

    For this to happen, there have to be very motivated sellers. Their motivation can come from a variety of causes: tax loss selling, getting spooked, changing their minds, etc. Of course, all these reasons can combine together (that is what we want!).

    So to put it in technical terms, I'm looking for massive overhead resistance. I want the longs to be screaming to get out!! As well I look at volume to complete the picture. If I see the price action crushing previous lows with volume...my attention is drawn. Ultimately I'm looking for a crescendo of volume, with each new low a higher volume. What this tells me is that the low volume is motivating the longs to get the heck out of Dodge!

    So that is one of the characteristics. But just because a stock is falling doesn't mean it is a Jan effect play. I whittle the list down to stocks that have a specific following. I want stocks that are in weak hands. Very weak hands preferably.

    What do I mean? Well, lets take IPOs for instance. A recent IPO is in weak hands. Why? Because the security doesn't have a well vested base of followers. The people who have probably bought it were pushed to do so by their local friendly broker. Who in turn was only pushing the darned thing to get his yearly bonus check.

    Another example of weak hands could be preferred shares. Why? Because the holders of preferred shares are usually retail. They want that dividend check every month. Maybe they need it for their expenses. Any person who has bought a preferred share is interested in income and totally risk averse. That makes them weak hands because they will bail at the first possibility of loss.

    Another example of weak hands could be closed-end funds. Why? Again, the story is one of retail holders. CEF are by far and wide the most retail security on the exchange. This group of holders will easily get spooked and bail. In other words, sell when they should buy and buy when they should sell.

    There are more but that sort of gives you an idea of what I'm looking for. So basically its lots of resistance which means the stock has worked its way lower (either sharply or grinding slowly) which translates into unhappy longs. We prefer these longs to be retail or 'weak hands' because they will find solace at year end in that fact that they can sell their dogs as 'tax loss' and at least get something in return.

    So the strategy is to look for this sort of action and buy on the weakness. To scoop up the baby when it is thrown out! I do this buy focusing on securities with the above mentioned characteristics during the middle to end of December. My hold time is only a few days and up to two weeks. Very short.

    This is a high probability play. I've found that it has around 80-85% accuracy. But unfortunately it isn't that high of a return that we get. I've found that a return of 5-6% is the best average you can expect. And it does hurt to be greedy!

    But the annualized return is amazing and it is why I go through the whole exercise. :)

    ok enough theory! I'll show you what I mean with a recent example. Lets take a look at BBK (my namesake save for a vowel). I've attached it below so you can see the 6 mth chart.

    As you can see it is a closed-end fund (check), it is a bond fund(check) and it is a recent IPO underwater (check) So all three elements I mentioned are present. Great so far.

    Now the chart. It doesn't look so great, if you are long. Which most people are because of the nature of the beast. Now look at the volume at year end. As the price was screaming down the volume was getting heavier and heavier, reaching a crescendo of panic. That is what I watch for. Sort of a GNP (with apologies to P2!). Also notice that this is the area of support from November.

    Now some practical things. Where should we enter? I enter with limit orders since these things can be very tricky and illiquid (although we are playing them at the most liquid time of the year!). I watch for a couple of things. I want the volume to fall. This tells me the sellers are finished. If that isn't there I watch for a small congestion pattern to unfold in mid-end of December. This would tell me all the sellers are being met with buyers.

    The exit: As I mentioned I only want 5-6% out of this. I'm not greedy. I begin to scale out at those levels. At the same time mindful of technical resistance. I am not at all worried if volume is very small in January. I know that we are told that a receding volume and a rising price is a no-no. But in this case it is a normal occurrence and nothing to panic over. It is the result of the extraneous situation that is the January effect.

    ok, I hope that was useful. If you are interested in some other examples take a look at SINT, LQMT, CIT, and RRE. They may not be as perfect as BBK but each has certain elements that I mentioned. Remember we want as many things to align as possible. But we can't have everything go our way!
     
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  2. Very interesting. Thanks for sharing. This isn't my kind of trading but it is nice to know what else is being done out there.

    ( so what is my kind of trading...?? who knows..?? )

    :confused:
     
  3. nice work
     
  4. Thanks, Babak, for the excellent post. I believe this is the first time I've ever seen/heard someone give a specific example of a 'January effect' trade.

    Maybe someday I can return the favor (to the board).

    AH
     
  5. Nice work Babak. Thank you.

    :)
     
  6. Nice.

    Do you also consider small caps?
     
  7. Babak

    Babak

    Yes, I also take a look at them, especially if they were taken public and are underwater.