Chart Advisor: January Barometer

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Wednesday, 29th December, 2021

1/ Can January accurately predict the rest of the year? 

2/ The January barometer track record 

3Trading tactics needed 

4/ The bottom line

1/ Can January Accurately Predict the Rest of the Year? 

The January Barometer is summed up in a single easy-to-remember phrase: “As January goes, so goes the rest of the year.” While there’s reasonable evidence the January barometer has some predictive use, for any chance of translating that into trading returns, you will also need judgment and skill.

While it is true that this simple principle failed investors during 2021, a case could be made that even though the numbers didn’t line up, the chart passed the eye test. As the markets recovered from the influence of the pandemic in 2020, the indexes ended that year in strongly positive territory. But January 2021 experienced volatility at the beginning and end of the month. This meant that the net difference between the opening price and the closing price for the month was negative. (See the blue line in the chart below.) 

However, 2021 ended up as a very strong year for the S&P 500 index.  So, was 2021 just a strange case? Or is there a pattern that could be followed. 

The January Barometer indicator was first printed in the annual publication “The Stock Trader’s Almanac,” authored by Yale Hirsch. He first mentioned it in his 1972 edition. The chart below gives the evidence of why the barometer and its catch phrase are worth keeping around. 

Since 1928, the S&P 500 has had 93 occasions to test the January Barometer, and in 64 of those years, the market did close in the direction that January took over the remaining 11 months of the year. By comparison, all other months, on average, were significantly less likely to be as well correlated as January. 

2/ The January Barometer Track Record 

The indicator’s performance over the past 93 years looks better because of the data from its first 60 years or so. In the most recent 30 years the results of the barometer seem lackluster by comparison. 

The chart below averages all price moves for the S&P 500 (SPX) over the past 20 years into a single seasonality graph. By this measure, observers can see that, on average, January seems to do exactly the opposite of the rest of the year. What could explain the difference? 

One explanation could be that the averaging of data into a seasonality chart could obscure the extreme moves that often appear in January, especially around earnings season. Traders would likely fare better using a few rules to guide their attempt at buying stocks in January, while buy-and-hold investors should likely prepare for a bit of volatility in that month.

3/ Trading Tactics Needed 

The two main problems with the January Barometer are, first, that its track record shows the indicator only forecasts correctly just under 70% of the time, and second, that it assumes investors will hold on through the index’s drawdown. During 2021 holding on through January would have worked out with only a minimum of nail biting, but that isn’t always the case for some years. 

The chart below shows that using a stop-loss to combat January’s volatility is a useful idea. As it turns out, the years where the barometer does correctly forecast the market appear to exhibit a smaller average drawdown and median drawdown compared to years where January goes one way and the markets another for the rest of the year. This suggests that a stop-loss order placed to allow only a normal degree of fluctuation might come in handy. 

As the graph below indicates, if you place a 10% stop-loss order below your entry, this may protect your capital better regardless of how January plays out. The stop-loss protects capital well enough that it saves investors from losses in bad years and doesn’t hurt them in good years. Such a rule would have been triggered about 30 times out of the past 91 years, giving investors a chance to protect against an average of 11% additional adverse moves. 

4/ The Bottom Line 

The truth is the January Barometer is right often, but it leaves a lot to be desired as a trading or investing rule. Instead, consider it an indicator of overall market health. That way, you can maintain a bullish stance and use it to improve confidence in your trading during a year when January has closed higher for the month. 

Originally posted on 29th December, 2021

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