The January Effect and the market effect

Traders can be more superstitious then hockey players, but over the years the January effect has gained credibility-whether it is deserved or not is another conversation. The saying is, "As goes January, so goes the year". Some people use the first week of January, some use the month.

If we look at the gains for the first week of 2011 we come up with a gain of +1.10% for the week, this isn't really much of a move, we have often seen 1 day moves of 1% or more. For the month of January the gain was 2.26%, but that was only because of January 31st, take away the 31st and go to the 30th and the gain wasn't much different then the first week, +1.49%. So how did the year go? A loss of  1.12%, which is not adjusted for the value of the dollar during unprecedented QE/dollar devaluation.

How did we finish this week?  A gain of...... drum roll.....   .03%, that's right! It may not have felt that way, but this is why I encourage you to look at the bigger picture and not the daily fluctuations.

The important Russell 2000 closed the week at a loss of -.36%, the Dow, down -.29%. Only the NASDAQ 100 managed any kind of respectable, well any kind of gain, 1.45%. However the broad average of the NYSE index (a sample size that is roughly 20 times larger) ended the week down - .91%.

Seasonally, we are in the time of year that the market should be performing well. With all of the redemptions in mutual and hedge funds, there wasn't much sidelined cash waiting to flow back into the market. We saw unprecedented volatlity  in 2011 with the S&P-500 travelling 1234 points just from May 1 to December 1st, imagine what the range was for the year and after all of that movement we ended the year with a loss of 1.12%. THIS IS WHAT I MEAN WHEN I SAY THAT YOU ARE TRADING ONE OF THE MOST DIFFICULT MARKETS I HAVE EVER SEEN and traders who have been doing this since the 1950's agree. The market moves a lot but doesn't manage to put together any real moves or trends, it's something we haven't seen in a long time and some people have never seen it; it's something we have to adjust to.

In my opinion, with less Assets Under Management, the squeeze on funds to generate returns that normally would be found in the form of 1.5-3% of AUM in management fees, is going to be on, it is survival mode. This was evident in the end of year mass lay-offs on Wall Street. Hedge funds, regardless of their performance, make 1.5-3% of asset under management just in management fees, so a fund like John Paulson's flagship Advantage Plus fund, which lost 53% last year, lost more then half of their management fees. Who knows how much more the fund loss due to redemptions?

So what does this mean, volatility probably isn't going anywhere soon. I am a firm believer that the market will trend and my money is on down, but until then, I've been tinkering the last week with hit and run trades. This week the S&P returned +.03%, seeing this range bound market, which has been in effect for about 2 months now, I decided I'm going to take what the market offers and the BAC trades were great examples of how you can make money in even a flat market, it's better then sitting there watching every tick waiting for something to happen. The 30% and 57% 1 day returns (as well as a 5% and 10% return in 2 IWM trades) have me convinced that you can make money even in this environment and while my longer term positions are still in place, I'm not one for just sitting around when there's money to be made and I know several of you took the same trades and made out pretty well.

A lot will change in the market this year, the EU crisis will almost certainly get worse. The idea that the US economy can or has decoupled from the world is in my opinion is a self-deception. Who will the US export to? The US? We saw how the world financial system is one big spider web when the US housing crisis effected nearly every nation in the world, can we really expect that to be a one lane highway in which EU problems and Chinese problems won't have an impact on the US?

This is why it is important to be a lifelong student of the market, to adjust to the market. Look at how many examples we saw this week of traders being stopped out because they use technical analysis the exact same way it was used in 1940. Wall Street knows what traders will do for the simple reason that traders have not adapted or learned anything new. What traders are doing is the definition of insanity.

I've gotten a bit off track though, the point is January has started off with a fizzle not a bang. The much anticipated Santa Rally never came to town and the signs were there the whole time, see my Santa Claus Rally video posted 2 weeks ago.

In any case, I'm going to move model portfolio allocations to reflect an intermediate trend in which I'll use wider stops and have a longer term approach (when I say longer term, I actually mean a bit shorter then what I would normally consider long term-maybe a month or two time horizon) and a much shorter approach that will include trades like the BAC trades as well as trades that are swing oriented, from several days to a couple of weeks. I think it's important for traders to hit singles and doubles and keep confidence up with some winning trades that add to the pot. Investing should be fun as well as rewarding, most of us are here because we love the markets despite what they've become. Just sitting and waiting for longer term positions to take off is not healthy for a trader's mental state. What tends to happen is traders look at every single tick and every day and put too much emphasis on noise instead of seeing the bigger picture those trades are meant to represent.

Taking the short term trade opportunities is good for morale, it's good for keeping you focussed on the market and making observations and learning, it's good to expand your tool box and keep you on your toes. The bottom line is the market is changing and we need to adapt to those changes. I'm all ears if you have ideas you want to share, the diversity of our members is a huge asset.

I have some ideas that fall along the lines of what I have outlined above and will be back testing some of these strategies this weekend so keep your eyes open for some posts and if you have ideas you want me to back test, just shoot me an email.

Have a great weekend!