October Effect - Explained
What is the October Effect?
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Table of ContentsWhat is the October Effect?How Does the October Effect Work?The Disappearance of the October Effect
What is the October Effect?
The October effect is a recognized market assumption that the value of stocks will reduce during October. It is more of a psychological belief and not a real fact. This theory is a contrast to what statisticians believe. In the history of the stock market, many big declines in market took place in this very month, and this may shake the interests of many investors for this month. There are many events that resulted in loss of stocks, and because of which October has got this bad image. Some of them are the Panic of 1907, Black Tuesday (1929), Black Thursday (1929), Black Monday (1929) and last but not the least, Black Monday in 1987. Black Monday that occurred on October 19, 1987 witnessed the huge Dow fall 22.6% in just one day. Besides, the other black days were a major cause behind the Great Depression, that was an economic tragedy that persisted until the mortgage meltdown almost affected the whole world economy along. Key points
- The October effect revolves around a perceived assumption that stock prices will fall in October.
- Instead of logical facts, this effect is mainly based on the psychological perceptions.
- The October effect and other effects related to different months have mostly vanished in the last few decades.
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How Does the October Effect Work?
What makes the October effect are the events (such as Black Tuesday and Black Thursday in 1929 and Black Monday in 1987) that made the stock market crash miserably. There is no proven evidence or theory that supports the fact that the stocks decline in the month of October. It is a mere assumption or more of a psychological thing because of big crashes occurring during this month. However, the October effect is more of an overhyped effect. Even if this month is associated with shady stock market titles, focusing on just this month is still considered to be statistically insignificant. Considering other calendar months, September has faced more decline in stocks than October. Analyzing the previous data, the month of October has seen a noticeable end of many bear market as compared to the initial phase. And this makes October significant for contrarian buying. Investors who have a negative vibe for a specific month will be inclined to buy more in that month. It would be right to say that the month of October is said to be the most fluctuating or inconsistent month for stocks. As per the research from LPL Financial, bigger market swings (at least 1%) have been taking place in October in the S&P 500 as compared to other months since 1950. Many believe that it is due to the U.S. elections taking place later in the month of November. Instead of October, it is September that holds more records of stock market crashes. The factors that were responsible for 1907 and 1929 crash had accelerated in September or maybe before that, but it was the effect that became visible later in October. Talking about the year 1907, there were tensions present in March already. And the other major crash of 1929 took place when the Fed put a restriction on margin-trading borrowings in February, and increased interest rates. Considering the month of October alone, the average returns on Dow Jones Industrial Average from 1990 to 2014 was 0.2%.
The Disappearance of the October Effect
The October effect has nothing to do with the figures or numbers. The returns in the month of October have been genuine for over a century, and thats why, there is no valid evidence that give October the title of a losing month. There are many past events that have fallen in October, and the word Black Monday associated with it seems to be scarier. But then, its not the case that the markets have not crashed in any other month than October. Many historical events such as the dotcom crash or the financial crisis in 2008-09 are still unforgettable for investors, but still, they are not considered black events, or the specific months in which they occurred are not exaggerated either. Lehmans crash took place in September on a Monday, but was not entitled as another Black Monday. Now, both the media and Wall Street have no interest in considering such events as Black days. Also, there are international investors who share different perceptions about a calendar year. The end of October effect was unavoidable, and it was more of an intuition followed by some random probabilities for creating an assumption or misconception. Somehow, it is a matter of misfortune that it specifically brought October into picture. If all financial crisis, and market crashes were to come only in October, wont it be a relieving moment for all investors?