What Is the Monday Effect?
The term Monday effect refers to a financial theory that suggests that stock market returns will follow the prevailing trends from the previous Friday when it opens the following Monday. According to the theory, if the market was up on Friday, it should continue through the weekend and resume its rise on Monday while the reverse is likely to occur if the market was down on Friday. The Monday effect is important for day traders and other market watchers who rely on it to predict where the market will move at the beginning of the trading week.
- The Monday effect is a financial theory used by some market watchers that states that Monday stock market returns follow those of the previous Friday.
- According to the theory, if the market moves up and closes higher on a Friday, it will open higher during the first few hours of trading on the following Monday and vice versa if it closes lower.
- It was first reported by Frank Cross in a 1973 article published in Financial Analysts Journal.
- The Monday effect has been attributed to the impact of short selling, the tendency of companies to release more negative news on a Friday night, and the decline in market optimism a number of traders experience over the weekend.
- The Monday effect remains a much-debated topic.
Understanding the Monday Effect
There is no accurate way to predict where the market will head. That's because market movement depends on a number of different factors, including economic conditions, breaking news, supply and demand, government policies, and speculation among others. Market and stock watchers must come up with a strategy that can help them guess which way things will swing in order to make their moves. One of these techniques is the Monday effect.
As noted above, many day traders and market watchers use the Monday effect to help them figure out which way the market will move. According to this theory, the equity market is poised to replicate the returns from the close of Friday's trading day on the following Monday's market open. So if it closes up on Friday, it should open the same way the following Monday. If it drops before the close on Friday, the market will open lower on Monday.
Some studies show a similar correlation, but no one theory can accurately explain the existence of the Monday effect. The rationales or reasons behind the existence of the Monday effect are not well understood. But when reviewed in terms of weekly trading on any given Monday, equity markets experience opening performance that mirrors Friday's closing performance.
The Monday effect is sometimes known as the weekend effect, which describes the phenomenon that Monday returns are often significantly lower than the previous Friday's returns.
History of the Monday Effect
Frank Cross first reported the anomaly of the Monday effect in a 1973 article entitled “The Behavior of Stock Prices on Fridays and Mondays,” which was published in the Financial Analysts Journal. According to Cross, the average return on Fridays exceeded the average return on Mondays and there is a difference in the patterns of pricing changes throughout the day. It usually results in a recurrent low or negative average return from Friday to Monday in the stock market.
Some theories say the Monday effect has a lot to do with the tendency of companies to release bad news on a Friday, after markets close, which then depresses stock prices on the following Monday. Others think the Monday effect might be attributed to short selling, which would affect stocks with high short interest positions. Alternatively, the effect could simply be a result of traders' fading optimism between Friday and Monday.
The Monday effect has been a mainstay anomaly of stock trading for years. According to a study by the Federal Reserve, there was a statistically significant negative return over the weekends prior to 1987. The study did mention that this negative return disappeared between 1987 and 1998. Since then, volatility over the weekends increased again, rendering the phenomenon of the Monday effect a much-debated topic.
Example of the Monday Effect
Here's a hypothetical example to show how the Monday effect works. Let's say the Dow Jones Industrial Average (DJIA) rose steadily during the last hour of trading on a Friday and closes at 20,000. According to the Monday effect, once the Dow Jones re-opens the next Monday morning, the upward performance will continue for the first hour or so of trading. From 20,000, the Dow Jones may also rise during the early hours of trading.