Wall Street, as far as we know, does not give out free lunches. There are no easy strategies to outperform the market, with scores of investors continuously on the lookout for even a tiny percentage of additional performance. Nonetheless, some trade oddities appear to endure in the stock market, and many investors are intrigued by them.
As these oddities are interesting to examine, investors should be aware that oddities can appear, vanish, and reappear without notice. As a result, adopting any trading technique automatically might be dangerous, but paying close attention to these three occasions could pay off for astute investors.
1. The January Effect
The January effect is a popular occurrence. Stocks that underperformed in the fourth quarter of the previous year tend to do better than the markets at this time, according to this theory. The cause of the January effect is so obvious that it’s difficult to term it an oddity. Late in the year, investors generally want to get rid of failing equities so that their losses can be used to balance capital gains taxes. This is referred to as “tax-loss harvesting” by many.
Considering panic selling can be autonomous of a company’s real fundamentals or valuation, “tax selling” can drive these assets to levels where buyers will be interested in January. Similarly, to avoid being caught up in the tax-loss selling, investors would often refuse to buy poor stocks in the fourth quarter and wait until January. Due to this circumstance, before January 1, there is excessive selling pressure, and after January 1, there is excessive buying pressure, resulting in this impact.
2. The Days of the Week
The “days of the week” oddity irritates efficient market believers since it not only looks to be accurate, but it also makes no sense. According to research, equities rise more on Fridays than Mondays, with a tendency toward favorable market performance on Fridays. It’s not a significant difference, but it’s been there for a long time.
On a basic level, there is no justification for this to be the case. Certain psychological elements may be at play. As traders and investors look forward to the weekend, there may be an end-of-week optimism in the market. Conversely, the weekend may provide an opportunity for investors to brush up on reading, details, and trends about the market, and create pessimism heading into Monday.
3. Small businesses tend to surpass large corporations
Smaller businesses (those with a lower capitalization) trump larger businesses. The small-firm impact is a reasonable oddity. The economic expansion of a firm is essentially what drives its market performance, and smaller companies have considerably longer growth trajectories than larger companies.
To grow 20%, a company like Microsoft (MSFT) could need to generate an additional $20 billion in sales, but a smaller company might just require an extra $140 million in revenue. As a result, smaller businesses may often grow significantly quicker than larger businesses.
4. Low Book Value
Stocks with lower-than-average price-to-book ratios outperform the market, according to a comprehensive scholarly study. Purchasing a collection of stocks with low price/book ratios has been proved in multiple experimental portfolios to outperform the market.
Even though this oddity makes sense in a way as inexpensive stocks should draw buyers’ interest and backtrack to the mean—it is, regrettably, a weak oddity. Indeed low price-to-book stocks as a group outperform, individual performance is unpredictable, and large portfolios of low price-to-book equities are required to observe the benefits.
Empirical data indicates that equities at both ends of the performance spectrum tend to reverse course in the next period (usually a year)—yesterday’s high players become tomorrow’s underachievers.
Not only is this supported by known facts, but the oddity also makes sense in terms of investment basics. If a stock outperforms the market, it is likely overpriced; similarly, underperformers are likely to be overpriced. It would seem reasonable to expect overvalued stocks to struggle (bringing their valuations back into line), and underpriced stocks to thrive.
People expect reversals to work, thus they are more likely to be successful. When enough people sell last year’s winners and buy last year’s losers regularly, the stocks will move in precisely the predicted direction, creating a self-fulfilling oddity.
Trading oddities is a dangerous method to invest in. Many oddities are not only fictitious in the first instance, but they are also unpredictably unreliable. Furthermore, they are frequently the result of big data studies that examine portfolios made up of lots of stocks that provide only a marginal performance benefit.
Similarly, it would appear to make sense to dump underperforming investments before tax-loss selling ramps up and to avoid buying underperformers until far into December.