By: Katie Gomez

Diamond hands are everywhere in the market—investors holding stocks long-term out of fear they’ll sell just before a dormant stock spikes (think GameStop). But in December, we see a different breed of Diamond Hand investors: those with short-term intentions. They buy now, planning to sell in January, thanks to the January Effect.

In this article, I’ll explore the origins of the January Effect, its validity as a tradable strategy, and why December sees an uptick in Diamond Hand activity. I’ll also highlight the stocks these investors are eyeing and what to expect in the new year.

Market Context and Historical Patterns

The January Effect is one of the most widely recognized seasonal patterns in financial markets. It is characterized by the tendency for stocks, particularly small-caps, to rise in price during the first month of the year. Investment banker Sidney Wachtel first documented this phenomenon in 1942, and it has been extensively studied over the past eight decades.

Historical data shows that small-cap stocks have historically outperformed large-caps by an average of 2.5% during January, with this effect being most pronounced following years of significant market volatility. The pattern’s persistence can be traced through various market cycles, with particularly strong showings during post-recession recoveries and periods of accommodative monetary policy.

Tax Loss Harvesting 

Several theories can explain why the January effect influences the market and trading behaviors. Some argue that the effect stems from tax harvesting investors’ end-of-year tendency to sell off securities at a loss to offset their capital gains and lower their tax bills, prompting a sell-off. December’s unique market patterns create distinct trading opportunities driven by four key factors. Tax-loss harvesting leads institutional and retail investors to sell underperforming positions before year-end, creating temporary price pressure, particularly in small-cap stocks that may have struggled earlier in the year. This selling often reaches its peak in mid-December. In the new year, investors repurchase the stocks, creating a greater demand for a range of shares in the market, leading to the January effect. 

Window Dressing 

Simultaneously, institutional investors conduct year-end portfolio rebalancing, adjusting positions to optimize performance metrics and align with mandated investment guidelines. This rebalancing typically involves window-dressing their portfolios to make their end-of-year reports more attractive. Window dressing is when mutual fund managers buy the top-performing company stocks at the end of the year only to eliminate any losing assets or portfolio “weeds” to make their annual performance look stronger when it is time for their end-of-year reporting.

As more and more investors partake in this rebalancing act in December, rotating out of outperformers and into underperforming sectors, it creates more noteworthy volume spikes. Year-end profit-taking adds another layer of market dynamics as investors lock in gains on winning positions to secure annual returns. This activity often intensifies in the final two weeks of December, particularly in sectors with strong yearly performance.

New Years Effect 

Other investors argue that it is less about December buys, and more about a change in sentiment around selling come New Year’s. For instance, January is the best month to begin a new investment program because many of us are following the momentum of our New Year’s Resolutions, creating a newfound buzz/sentiment shift within the first couple of weeks. This theory can also be sustained by the holiday cheer of Christmas bonuses trickling into the new year. At the same time, many workers have the luxury of celebrating their end-of-year surplus by investing it back into the market, driving sentiment once again. However, regardless of its reasons, the January effect turns average traders into Diamond Hands every December like clockwork. The first step is understanding the market psychology behind the January effect.

The FOMO Factor in Seasonal Rallies

The anticipation of the January Effect creates significant FOMO pressure among investors who’ve witnessed previous winter rallies. Historical data showing small-cap outperformance during this period often drives increased buying activity, mainly when early movers generate notable gains. This psychological pressure intensifies when high-profile stocks or sectors begin showing momentum.

December frequently witnesses panic selling as investors react to tax-loss harvesting pressures and year-end portfolio adjustments. This emotional response can create oversold conditions, particularly in small-cap stocks that have underperformed throughout the year. Smart investors recognize these panic sales as potential entry points, understanding that the fundamental value of quality companies remains unchanged.

The Power of Diamond Hands

The “diamond hands” strategy – holding positions despite market volatility – proves especially valuable during the winter season. Historical data shows that investors who maintain positions through December’s volatility often capture significant gains in January. This approach requires:

• Strong conviction in fundamental analysis
• Resistance to short-term market noise
• Understanding of seasonal patterns
• Proper position sizing to maintain confidence

To trade like a diamond hand, you must also follow the volume analysis during this period, which often reveals predictable patterns: increased selling pressure early in December, declining volume into the holiday period, and finally, a surge of institutional activity in the year’s final trading days. Understanding these volume patterns helps traders identify optimal position entry points that capture the rebound of the January Effect.

While winter trading patterns offer short-term opportunities, successful investors balance these with longer-term strategic positioning. December’s market dynamics often disconnect price and value, particularly in small-cap stocks, presenting opportunities for practical trades and strategic position-building for longer-term holdings.

Why Should We Hold?

Market performance analysis over the past two decades shows that investors who held positions through December volatility into January achieved significantly higher returns than those who sold during year-end pressure. The data reveals a consistent pattern: small-cap stocks that experienced selling pressure in December have averaged 2.7% higher returns in January than their large-cap counterparts. 

This effect is particularly pronounced in growth sectors, where recovery rates following tax-loss harvesting historically exceed 3.5%. Risk-adjusted returns favor the hold strategy, showing better risk-reward profiles for positions maintained through the winter than tactical trading attempts. Sector-specific patterns indicate technology and consumer discretionary stocks benefit most from this phenomenon, with AI-focused companies showing even stronger recovery rates in recent years. These statistics, combined with the current market setup featuring oversold conditions in quality small-caps, suggest that maintaining positions through December could position investors for optimal returns as the January Effect takes hold.

Since small-cap stocks and consumer discretionary growth sectors are becoming oversold and undervalued, new small-cap stocks, such as AI-focused companies and even other assets like cryptocurrency, will emerge. While many Diamond Hands have been part of crypto since the beginning, starting with Bitcoin, the newest hot commodity to stash in your crypto wallet has been XRP, Ripple’s token that has tripled its value in the last three months and continues to rise. Outside of crypto, we can expect AI to be another frequently mined asset for traders in December, as they are at the peak of focus for small-cap stocks following Trump’s election. Focusing on the momentum of these two sectors will help guide you into a lucrative 2025 following the January Effect. 

In conclusion, following the January effect, taking a month dedicated to holding stocks sounds counterintuitive to some. Diamond hands are often misunderstood and made fun of by other traders because you must sell eventually to make money in the market. However, maybe they know something we don’t; maybe they just know that sacrificing immediate gratifications and playing the long game often pays off. We label them as traders who lead with fear, but what if they are just traders who don’t lead with greed? What if they trade with a bigger picture in their minds?

If you want to see for yourself, now is the time; if there is a month to hold, it’s December. Past market data presents a compelling argument for maintaining positions through the winter months, especially in small-cap stocks, so why ignore it? What do we have to lose by being patient? Invest, hold, and focus on what’s important this holiday season: spend time with your loved ones, watch It’s a Wonderful Life, eat some good food, and reevaluate in the new year. 

References 

A. K. Cheema, et al. “The Cross-Section of the January Effect.” Journal of Asset Management. Vol. 24 (2023). Pages 513–530.

Lisa R. Anderson et al. “Yes, Wall Street, There Is a January Effect!.” College of William and Mary working papers. (March 2005.) Page 1.