How Human Instinct Can Help You Profit
When I was a child, I was fascinated by the face on Mars. As farfetched as the idea of an alien artifact seemed, to me the 1976 photo taken by the Viking I spacecraft really does resemble a humanoid face, complete with eyes, nose, and mouth.
High-resolution photos taken on another NASA mission around the turn of the century proved that the face was merely an illusion created by sunlight hitting a mesa at a certain angle. In more recent photos taken under different lighting conditions, that same mesa looks nothing like a face.
I certainly wasn’t the only one to think that 1976 photo looks like a face. The human brain is wired to detect patterns, probably a part of our survival instinct so that we could recognize danger before it was too late. There’s even a fancy word to describe the tendency for us to perceive patterns and meaning in seemingly random things—apophenia.
Today, living in civilized society, we don’t have to deal with the constantly lurking dangers that our early ancestors faced on a daily basis, but it doesn’t mean recognizing patterns isn’t useful. For investors, it could even help make a lot of money.
Pattern Recognition in Investing
For example, if you can recognize patterns in a stock’s movement—when it tends to group, when it tends to go down—you would be able to ideally buy it right before it repeats the up move and sell it before it repeats the down move. Of course, there’s no such thing as a fail-proof pattern. However, if you can identify a trend that occurs consistently most of the time, then you can tilt the probability of success in your favor.
Another challenge is to distinguish between a legitimate pattern and something false. Let’s take a look at one well-known example of a market pattern called the January Effect.
The term refers to the supposed tendency of stocks to rise in the month of January. The most common reason given for the effect is that after investors sell stocks to harvest losses for tax purposes at the end of a year, they will then reinvest that cash back into stocks in January the next year. All else equal, the reinvestment of the cash has a net positive effect on the market.
Fact vs. Myth
The explanation sounds reasonable enough, but does the data actually back up the claim? Let’s take a look at the return of the S&P 500, proxy for the U.S. stock market.
The table shows the S&P 500’s total return (including dividend reinvested) in every January since 2000. Including this year’s strong January, the S&P 500 has had a positive return only 11 times in 24 years! So much for the January Effect!
Furthermore, the down Januarys have occurred in the context of a strong market. In the last 23 years, from 2000 – 2022, the S&P 500 has achieved a positive return 17 times and a negative return only 6 times. In other words, you can’t blame the negative January returns on an overall down market.
To be fair, if we went back to the beginning of the S&P 500 in 1928, then there have been significantly more positive Januarys than negative.
However, even if there was something to it back way in the past, the January Effect has been at best a coin flip for the last two decades and change.
This doesn’t mean you shouldn’t buy stocks in January. However, it does mean that you shouldn’t buy stocks just based on the assumption that stocks tend to do well in January.
As our simple look at data has shown, in recent years the January Effect does not exist. It’s a myth that’s been perpetuated without checking facts.
Editor’s Note: Maybe you’re spooked by market volatility. Global risks are increasing, but there’s a way to profit from uncertainty…and our colleague Jim Pearce can show you how.
Jim Pearce is chief investment strategist of our premium trading service Mayhem Trader. After painstaking research, Jim has pinpointed one overlooked precious metal that could offer protection and massive profits, come hell or high water. Click here for details.