Researchers have witnessed many types of trends in financial markets and, quite often, such trends repeat themselves over time. Provided below are some examples of these trends:
“The January Effect” is one example of such a trend – describing the general seasonal increase in stock prices during the month of January. Analysts generally attribute this occurrence to an increase in buying after the low prices of December when investors, typically engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off. Another explanation is that investors often use their year-end cash bonuses to purchase investments for the following months.
“The Size Effect” – the relative advantage the size of a company has on returns -is another example of a trend. Some analysts suggest investing in a small company may lead to higher potential returns than investing in larger companies, even after accounting for unsystematic risk. They believe that companies with smaller market caps tend to outperform those with larger market caps.
“The Momentum Effect” – the rate of acceleration of a security’s price or volume – is yet another example. In investments, momentum refers to the rate of change in price movements of a particular asset i.e. the speed at which the price is changing. It has been well researched that companies that had performed best in the past (6-12 months ago) tend to perform better in the future than firms that performed worse over the same period. Reasons for this effect are debated, but they can most likely be attributed to investor psychology – people would like to invest in something trendy and ‘hot’.
When an investor sees a growing trend in a stock’s price, earnings or revenues, they are often enticed to take a long or short position in the stock in the hope that this momentum or ‘trend’ will continue in a way that will benefit them.
Such examples may then lead to the view that markets are, in fact, inefficient.