Is there a “January Effect” in Forex?

Pundits often talk about a certain “January Effect” that may or may not occur in stock markets. Forex traders wonder if a similar effect might also take place in the Forex market and, as it's January right now, it seems like a good moment to investigate whether or not some kind of “January effect” exists in Forex.

What is the “January Effect”?

When people talk about the “January Effect” manifesting in stock markets, they are actually talking about two different phenomena:

1. A supposed tendency of stock markets to rise during the month of January. If this were true, it would mean there would be an edge in buying stocks at the beginning of the month and selling at the end of January.

2. A supposed tendency of the yearly price change of stock markets to follow the January price change. If this were true, it would mean there would be an edge in waiting until the END of January, and buying stocks if prices had risen during January, or alternatively selling if prices had fallen over the month. Trades would be exited at the end of the year.

Extrapolating from a belief that either or both of these assumptions are correct, it could then be said that the U.S. stock market affects the U.S. dollar which in turn is the major engine behind the Forex market, and as such there must be some kind of “January effect” in the Forex market as well.

Maybe it is best to begin by determining whether there is evidence of some kind of “January effect” playing out in the U.S. stock market by looking at historical price movements of the S&P 500 Index.

Do U.S. Stocks Tend to Rise in January?

This question should actually be rephrased slightly in order to make it more accurate. The real question is not whether stocks tend to rise in January – the U.S. stock market has a clear long bias, meaning that any month is on average a rising month. The question is, therefore, not whether stocks tend to rise in January, but whether stocks generally rise in January more than they do in other months. If we look at the S&P 500 Index since 1950, we find that the average January during this period has seen a rise of 1.79% in the Index. However if we take every single month during this 65 year period, we find that the average month has seen a rise in the Index of only 0.65%. This shows clearly that since 1950, stocks have tended to rise almost three times more in January than they do in any given month.

The next question is whether what happens in January to the stock market is predictive of what will happen during the rest of the calendar year.

Does U.S. Stock Performance in January Foreshadow the Rest of the Year?

We can look at this clearly by using Excel to calculate the correlation coefficient between the performances of the Index over the month of January as compared to its performance over the next 11 months. There is indeed a positive correlation coefficient of 0.25, which is a meaningfully strong number. However we could ask whether this is the same for any month, i.e. what is the correlation between the performance of any given month and the performance over the subsequent 11 months? The answer is that sampling every month gives a correlation coefficient of only 0.016, so this is very indicative that the old Wall Street saying “As goes January, so goes the year” has some historical truth to it. However it should be noted that of the 26 negative Januarys included in the sample, only 11 presaged a negative year, so the effect is greater on the long side.

Now that we have established that there seems to be some empirical truth to (both forms of) the January effect, let’s see if we can apply this to Forex.

Does the U.S. Dollar Tend to Rise in January?

We can test this by examining what happened to the U.S. Dollar Index during historical Januarys. For convenience, I used historical data published by the U.S. Federal Reserve showing the Broad Nominal Index from 1974 to date. Looking at these 42 January months, the average month produced a positive change in the Index of 0.48%. Additionally, 60% of these months saw a positive rather than negative change in the Index. This suggests that the U.S. Dollar has tended to rise in January rather than fall, albeit by considerably less than the S&P 500 Index.

Is the Calendar Year for the U.S. Dollar Driven by January Performance?

Again, all that we need to do is calculate the correlation coefficient of the January performances with the performances for the remainder of that calendar year. There is a positive correlation coefficient of 0.18, which is a meaningfully strong number. If we compare the result for the subsequent 11 months correlation to every month within the sample – not only Januarys – we get a correlation coefficient of 0.12. This suggests that there is some “January driver” effect, but it is quite small, certainly compared to the effect shown by the S&P 500 Index.

Conclusion

Both the S&P 500 Index of the major 500 U.S. stocks and the U.S. dollar have exhibited both variations of the “January effect”: both have shown a tendency to rise during the month of January, and for January’s performance to drive the rest of the calendar year. However what really stands out is that both the U.S. stock market and the U.S. dollar have shown clear tendencies to rise during the month of January.

Adam Lemon

Adam Lemon began his role at DailyForex in 2013 when he was brought in as an in-house Chief Analyst. Adam trades Forex, stocks and other instruments in his own account. Adam believes that it is very possible for retail traders/investors to secure a positive return over time provided they limit their risks, follow trends, and persevere through short-term losing streaks – provided only reputable brokerages are used. He has previously worked within financial markets over a 12-year period, including 6 years with Merrill Lynch.

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