Is There a January Effect in Forex?

01/06/2016 6:00 am EST

Focus: FOREX

Adam Lemon, of DailyForex.com, examines if there’s evidence of some kind of January effect playing out in the US stock market—by looking at historical price movements of the S&P 500 Index—and if so, whether or not it has any correlation to the price action of the US dollar.

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 US stock market affects the US 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 US stock market by looking at historical price movements of the S&P 500 Index (SPX).

Do US 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 US 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.

NEXT PAGE: Some Empirical Truth…

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Does US 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 US Dollar Tend to Rise in January?

We can test this by examining what happened to the US Dollar Index during historical Januarys. For convenience, I used historical data published by the US 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 US 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 US 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 US stocks and the US 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 US stock market and the US dollar have shown clear tendencies to rise during the month of January.

By Adam Lemon, Contributor, DailyForex.com

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