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Market anomalies are market patterns that do seem to lead to abnormal returns and contradict efficient market hypothesis (EMH), to understand market anomalies lets have a look what efficient market hypothesis says . The efficient market hypothesis all stocks are properly priced and abnormal returns cannot be earned by searching for mispriced stocks. Furthermore, because future stock prices follow a random walk pattern, they cannot be predicted. In short : Fair play in market All players in the market are rational Their is transparency in market Market is regulated
But in realistic terms there is no efficient market hypothesis due to market anomalies which are of different types and are explained below :
January Barometer
The January Barometer applies to all stocks, most of the time. It is simply stated, "As January goes, so goes the year .So if the stock market rises in January, it is likely to continue to rise by the end of December
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Liquidity Effect
It says stocks of small firms usually have relatively few outstanding shares of stock, few shares trade at any particular time, which makes the stocks relatively illiquid. Illiquidity increases bid/ask spreads, which increases risk, and therefore, such stocks command a higher risk premium as compensation
Neglected-Firm Effect
The neglected firm effect is the observation that small firms that are not covered extensively by analysts tend to outperform the market. But since almost all neglected firms are small firms, this may simply reflect the basic fact that small firms have a greater potential for growth, so the neglected firm effect may not represent an independent effect. This effect may also arise because when small firms become larger, their coverage by analysts increases, and their stock float also increases, which allows more institutional investors to buy the stock. Institutional investors are reluctant to buy stocks with a limited float, since any major buying or selling can have a significant impact on the stock price.
January Effect
The January effect says that smaller firms that have outperformed in final quarter will increase their value in January. This creates an opportunity for investors to buy stock for lower prices before January and sell them after their value increases. The January Effect was first observed in, or before, 1942 by investment banker Sidney B. Wachtel. It is the observed phenomenon that since 1925, small stocks have outperformed the broader market in the month of January.
Earnings Announcements
Earnings announcements can have variable effects on stock prices. Sometimes stock prices go up until the earnings are announced, then decline on the newsor they may decline before the announcement if expectations are not positive. Expectations usually are based on analysts reports, and their forecast of future earnings.
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Book-to-Market Ratios
It has generally been observed that stocks of companies with high book-to-market ratios outperform stocks with low book-to-market ratios. This effect could be explained by the fact that companies with low book-to-market ratios tend to be companies that investors expect to grow rapidly. However, rapid growth continually declines as companies grow largerhence, growth in stock prices will be diminished as the P/E ratio declines as future expectations of further growth are lowered. As the P/E ratio drops, the return also drops.
. Reversal Effect
In this anomaly, it is said that stocks that are found on either end of the spectrum may experience a reversal over certain period s of time, usually in about a year. This means that stocks that are outperforming the market may tend to reverse course in the next period. The underperformers, on the other hand may have the tendency to reverse direction and begin outperforming the market.
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