As the holiday season gets closer, many traders attempt to take advantage of something that has happened in the marketplaces in the past. Many fund managers, attempting to unload some of the weaker stocks (or other assets) in their portfolios, make mass sales, and this has historically driven prices down for some assets. Over the course of the last few decades, many people have observed this trend and have tried to take advantage of it in different ways. One way has involved buying these stocks at the discounted prices and waiting for them to bounce back up, and the other, more short term method, involves riding these falling prices by going short on the position and profiting as prices continue to drop.
This is a dangerous strategy to try and use on your own. Just because it is a method that some people have used successfully in the past does not mean that it is actually a valid way to make money. In fact, subsequent research on the “January Effect” has shown that it isn’t a universal phenomenon, doesn’t happen every year, and when it does happen, the traders that profit from it generally do so because of dumb luck, and not actual trading skill.
However, just because it’s not something that you should be trying to predict and attempt to profit from doesn’t mean that it can’t hurt you. Market psychology is a powerful tool, and it can help you a ton, or it can hurt you a ton. This leads to a big problem because suddenly, you are unsure of how to proceed in your trading.
The answer isn’t quite clear on what you should do to avoid this. One answer that some turn to is to pull their money out and wait until things are more predictable. This is a fine approach. Although you won’t lose money, you can’t make money either. This is a good risk-averse strategy, but certainly not ideal. Other traders just proceed as normal. This can have decent results, but it doesn’t offer you the protection that you need if you want to stay profitable.
A third approach is needed, one that takes the different trading climate into account. You need to acknowledge that there’s a chance of higher risk at this time of the year and then make adjustments to compensate for this fact. Hopefully, your trading will not be affected, but if it is, you want to be able to control the damage. One easy method is to limit exposure. You can do this by minimizing the amount of time that your money is in an open trade, such as with short term binary options or day trading, or you can trade with less money in the same manner that you have before. You can also introduce tighter stop-loss points if you decide to use more traditional methods and have a broker that will allow you to do this. Your methods should complement your trading style and what will benefit you most.
General theory in this area says that the January Effect will have a bigger impact on small cap stocks and not affect large cap stocks as much. This makes a lot of sense because the higher volume of large cap stocks helps keep their prices stable. Luckily for binary traders, these are the stocks that are most easily accessible. For day traders in the stock market, yes, the small cap stocks are the ones that pose the most risk. However, by having up to date price quotes and the best trading technology possible, you will be able to keep a better eye on what is going on and manage your risk in real time effectively.