6 Stock Market Anomalies to Be Aware of Before Investing
Even when you think you've got the stock market game figured out, you probably don't. While analysts and investors alike base their predictions on the efficient market hypothesis, a handful of anomalies occur time after time and offset the expected projections. If you're looking to invest, you'll want to stay aware of certain anomalies not only so you can use them to your advantage, but also so you can stay cautious around them and detect any faulty price increases.
Days of the Week
Some of these anomalies seem to be based solely on psychological factors, like the strange market fluctuations with the days of the week. It has persistently been shown that stocks are much more liquid on Fridays than Mondays, and the overall market performance is more positive on Fridays. It may be a result of an end-of-week optimism, followed by a Monday-morning pessimism. This is a little-understood anomaly, but seems to prove true consistently, and so may prove to be helpful to investors.
Other time-induced anomalies include the January Effect, which seems to make a bit more logical sense than the previous. Stocks that have underperformed in the fourth quarter tend to suddenly skyrocket and outperform in the month of January. This makes sense when you understand the practice of "tax-selling," where investors sell their lowest-performing stocks at the end of the year to offset their high net capital gains, resulting in lower taxes. The fluidity of these stocks reaches a high point in January, and does not accurately reflect the value of the company.
Stock Split Effect
The stock split effect is characterized by the sudden increase in a stock's price that occurs before and after the company announces a stock split. A stock split is when the company increases the amount of outstanding stocks, and reduces the price of each one (such as doubling the amount of stocks and cutting the price in half). This provides more stocks at cheaper prices without upsetting the company's market capitalization. The increase in liquidity during this time undoubtedly has a major effect on the stock's worth.
This is the dream of every investor: seeing quarterly or annual profits exceed every analyst's expectations. For whatever reason these earning surprises occur, they generally result in a gradual increase in the stock's price over time. The same goes for a negative surprise, however, resulting in a grim decline. If you are the owner of a skyrocketing stock, however, you are also at a higher risk of identity theft for those keeping an eye on those companies. In this situation, you might want to check out an online monitoring company such as IdentityTheftProtection.org to keep this anomaly to your advantage.
Smaller Firms Outperforming
Considering that the growth of a company has much to do with the value of its stock, this anomaly makes a lot of sense for investors to pay close attention to. Small firms outperform larger companies time and time again because of their excessive room for growth. It takes much less money for a small company to grow by five percent than it would for a large company. The stocks reflect this anomaly persistently, however, they do not reflect the overall value of the company.
While this anomaly makes sense according to investment principles, it can still prove to be a source of frustration for investors. The stock market tends to see reversed roles in performers—yesterday's under-performers become today's top players, and vice versa. This is probably a large part due to December's tax-selling habits, as well as the fluctuation in the cost of stock—a top-performer will see a decrease in liquidity due to the increased cost of its shares.
For anyone looking to take a stab at the stock market, it can be tempting to search for ways to "beat the market" and take advantage of anomalies such as these. But it's important to remember that these are in no way reliable market trends to depend your investments on, and should be used only to inform your decisions and help make more educated investment choices.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.