Making Sense Of Market

Anomalies
By Tisa Silver | September 28, 2008AAA |
In the non-investing world, an anomaly is a strange or unusual occurrence. In
financial markets, anomalies refer to situations when a security or group of
securities performs contrary to the notion of efficient markets, where security
prices are said to reflect all available information at any point in time.
With the constant release and rapid dissemination of new information, sometimes
efficient markets are hard to achieve and even more difficult to maintain. There
are many market anomalies; some occur once and disappear, while others are
continuously observed. (To learn more about efficient markets, see What Is
Market Efficiency?)
Calendar Effects
Anomalies that are linked to a particular time are called calendar effects. Some of
the most popular calendar effects include the weekend effect, the turn-of-themonth effect, the turn-of-the-year effect and the January effect.
Why Do Calendar Effects Occur?
So, what's with Mondays? Why are turning days better than any other days? It
has been jokingly suggested that people are happier heading into the weekend
and not so happy heading back to work on Mondays, but there is no universally
accepted reason for the negative returns on Mondays.
Unfortunately, this is the case for many calendar anomalies. The January effect
may have the most valid explanation. It is often attributed to the turn of the tax
calendar; investors sell off stocks at year's end to cash in gains and sell losing
stocks to offset their gains for tax purposes. Once the New Year begins, there is a
rush back into the market and particularly into small-cap stocks.

Why Do Anomalies Persist?

These effects are called anomalies for a reason: they should not occur and they
definitely should not persist. No one knows exactly why anomalies happen.
People have offered several different opinions, but many of the anomalies have
no conclusive explanations. There seems to be a chicken-or-the-egg scenario
with them too - which came first is highly debatable.
Profiting From Anomalies
It is highly unlikely that anyone could consistently profit from exploiting anomalies.
The first problem lies in the need for history to repeat itself. Second, even if the
anomalies recurred like clockwork, once trading costs and taxes are taken into
account, profits could dwindle or disappear. Finally, any returns will have to be
risk-adjusted to determine whether trading on the anomaly allowed an investor to
beat the market. (To learn much more about efficient markets, read Working
Through The Efficient Market Hypothesis.)
Conclusion
Anomalies reflect inefficiency within markets. Some anomalies occur once and
disappear, while others occur repeatedly. History is no predictor of future
performance, so you should not expect every Monday to be disastrous and every
January to be great, but there also will be days that will "prove" these anomalies
true!

DEFINITION of 'January Effect'

A general increase in stock prices during the month of January. This rally is generally
attributed to an increase in buying, which follows the drop in price that typically happens in
December when investors, seeking to create tax losses to offset capital gains, prompt a selloff.

BREAKING DOWN 'January Effect'

The January effect is said to affect small caps more than mid or large caps. This historical
trend, however, has been less pronounced in recent years because the markets have
adjusted for it. Another reason the January effect is now considered less important is that

more people are using tax-sheltered retirement plans and therefore have no reason to sell at
the end of the year for a tax loss.

DEFINITION of 'Weekend Effect'

A phenomenon in financial markets in which stock returns on Mondays are often
significantly lower than those of the immediately preceding Friday. Some theories that
explain the effect attribute the tendency for companies to release bad news on Friday after
the markets close to depressed stock prices on Monday. Others state that the weekend
effect might be linked to short selling, which would affect stocks with high short interest
positions. Alternatively, the effect could simply be a result of traders' fading optimism
between Friday and Monday.

BREAKING DOWN 'Weekend Effect'

The weekend effect has been a regular feature of stock trading patterns for many years. For
example, according to a study by the Federal Reserve, prior to 1987 there was a statistically
significant negative return over the weekends. However, the study did mention that this
negative return had disappeared in the period from post-1987 to 1998. Since 1998, volatility
over the weekends has increased again, and the phenomenon of the weekend effect
remains a much debated topic.