How to Maneuver through Market Anomalies while Day Trading - dummies

How to Maneuver through Market Anomalies while Day Trading

At times the stock market exhibits behavior for which there is no logical explanation. As a day trader, these anomalies affect trading and, if navigated properly, present an opportunity for return

An anomaly is a market condition that occurs regularly but for no good reason. It can be related to the month of the year, the day of the week, or the size of the company involved. You have a choice: Go with what the market is telling you or go with what your indicators are telling you.

Many trading anomalies follow time periods, — which is not completely unexpected. But some of the calendar effects — the January effect, the Monday effect, and the October effect — make little logical sense, yet still influence trading.

The January effect creates a market up tick

Many years, the stock market goes up in the early part of January. Why? No one knows, but the guess is that people tend to sell at the end of December for tax reasons and then buy back those securities in January.

If stocks go up in January, then you can get a jump on the market by buying in December, right? And that would make prices go up in December. To get a jump on the December rally, you could buy in November. And that’s exactly what people started to do, and the once-pronounced January effect is now weak to non-existent. (People still talk about it, though.)

In an efficient market, people eventually figure out these unexplained phenomena and then trade on them until they disappear. Use these anomalies as a way to gauge psychology, not as hard and fast trading rules.

The Monday effect causes stock blues

The market seems to do more poorly on Monday than on the other days of the week. And no matter what the evidence shows (the research is ambiguous, and the findings vary greatly based on the time period and the markets examined), many traders believe this to be true, so it has an effect.

Why? There are two thoughts. The first is that everyone is in a bad mood on Monday because they have to go back to work after the weekend. The second is that people spend all weekend analyzing any bad news from the end of the prior week and then sell as soon as they get back to the office.

The 2008 stock market crash happened on a Monday. Over the previous weekend, the different regulatory agencies decided to allow the old-line brokerage firm of Lehman Brothers to fail. The firm failed to open on Monday, September 15, and the rest of the market went into a tailspin.

The October effect yields market “crashing” blows

The stock market has had two grand crashes and one smaller but profound one, all in October:

  • October 29, 1929: On this day, known as Black Tuesday, the Dow Jones Industrial Average declined 12 percent in one day as market speculators caught up with the less rosy reality of the economy. This crash kicked off a general decline that contributed to the Great Depression of the 1930s.

  • October 19, 1987: This day, known as Black Monday, saw the Dow Jones Industrial Average decline 23 percent. No one is really sure why this crash happened, but it did.

  • October 13, 1989: On this day, the Dow Jones declined 7 percent in the last hour of trading when a leveraged buyout for United Airlines fell through.

Of course, bad things happen in other months. The crash in the NASDAQ market that marked the end of the 1990s tech bubble took place in March 2000, but no one talks about a March effect. The 2008 crash took place in September; maybe, the October effect is starting earlier in the year.