foxex: January Barometer

Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Tuesday, December 31, 2019

1. Does January predict the rest of the year?

2. The January Barometer track record

3. Solving the problems with this indicator

Does January Predict the Rest of the Year?

The January Barometer is summed up in a single easy-to-remember phrase: "As January goes, so goes the rest of the year." This tidy maxim seems to have reasonable evidence to back up its record for prognostication, but trading it might require judgement and skill.

This indicator was first printed in the publication "The Stock Trader's Almanac," and authored by Yale Hirsch who first mentioned it in his 1972 edition of the book. The pie chart below shows the strong reason why such a phrase would be considered valuable information. Since 1928 the S&P 500 has had 91 occasions to test the January Barometer, and on 63 of those years the market did close in the direction that January took over the remaining 11 months of the year. By comparison all other months, on average, were significantly less likely to be as well correlated as January.

The January Barometer Track Record

The indicator's performance over the last 91 years may look better in the past than in recent years. The chart below averages all price moves for the S&P 500 (SPX) over the past twenty years into a single seasonality graph. By this measure observers can see that on average, January seems to do exactly the opposite of the rest of the year. What could explain the difference?

The averaging in seasonality charts obscures the extreme moves that can occur through the year and often appear in January, especially around earnings season. Traders would likely fare better using a few rules to guide their attempt at buying stocks in January, while buy-and-hold investors should likely prepare for a bit of volatility in that month.

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Solving the Problems with this Indicator

The two main problems with the barometer are first, that its track record shows the indicator only forecasts correctly just under seventy percent of the time, and second, that it assumes investors will hold on through the index's drawdown. Over the years this has proved to be problematic. With at least a dozen occasions of more than a 30% drop in market prices over the last century, it becomes important for investors and traders alike to be forewarned and forearmed.

The chart below shows that the January Barometer helps with this somewhat. As it turns out, the years where the Barometer does correctly forecast the market appear to exhibit a smaller average drawdown and median drawdown comparted to years where the January goes one way the markets another for the rest of the year. This suggests that a stop-loss order placed just beyond the normal degree of fluctuation seen in years where the market is slightly better behaved might come in handy.

In fact as the graph below indicates, if you place a 10 percent stop-loss order below your entry, this will protect your capital better in non-matching years (years where the barometer doesn't predict the market) as compared to matching years. Such a rule would have been triggered about 30 times out of the past 91 years, giving investors a chance to protect against an average of 11 percent additionally adverse moves.

The Bottom Line

The January Barometer is right more often than not, but it leaves a lot to be desired as a trading or investing rule. Instead, consider it an indicator of overall market health. That way you can maintain a bullish stance and use it to improve confidence in your trading during a year when January has closed higher for the month.