The structural theories of technical analysis are based on repetitions of previous price patterns. Price patterns are believed to be regular over long periods. Many structural theories exist, some of which are esoteric, such as lunar phases or hemlines on dresses to predict the direction of the stock market. These types are not discussed in this book.
The January effect is a theory that small-cap stocks post large returns
in January. Technical analysts monitoring the DJIA monthly have
found seasonal patterns occurring in December, January, July, and
August. Some attribute the seasonal pattern in December and
January to tax planning. In December, many investors sell stocks
whose values are depressed to produce capital losses that can then
be offset against other capital gains. This action of selling further
depresses the prices of these stocks, which presents opportunities
for investors to buy them back in January, which results in a surge
in their stock prices. This is known as the January effect. Historically,
the prices of small-cap stocks have risen slightly in January.
Gottschalk reported that during the period 1982–1987 small stocks
increased by 4.2 percent annually as compared with 3.8 percent for
larger stocks in January (Gottschalk, 1988, pp. C1, C16).
The following questions give some perspective on the gravity
of the January effect: Which stocks will increase in January? Will they
include the stocks in your portfolio? Maybe, maybe not! What about
a bear market? During the bear markets of 1978 and 1982, the prices
of small-cap stocks lost ground in January. Will the small percentage
increases cover the transaction costs of buying and selling?
The same questions can be asked about summer rallies in the
markets. The theory of a summer rally says that the stock market
rises during the summer months.
Elliott Wave Theory
The Elliott wave theory is based on the premise that stock prices
move in a five-wave sequence when they are following a major
trend and in a three-wave sequence when they are moving against
a major trend. Long waves can last longer than 100 years, and
subwaves have short durations.
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