DEFINITION of October Effect
The October effect is a theory that stocks tend to decline during the month of October. The October effect is considered mainly to be a psychological expectation rather than an actual phenomenon as most statistics go against the theory. Some investors may be nervous during October because the dates of some large historical market crashes occurred during this month. The events that have given October the reputation for stock losses have happened over decades, but they include the Panic of 1907, Black Tuesday (1929), Black Thursday (1929) Black Monday (1929) and Black Monday (1987). Black Monday, the great crash of 1987 that occurred on October 19 and saw the Dow plummet 22.6% in a single day, is arguably the worst single day. The other black days, of course, were part of the process that lead to the Great Depression - an economic disaster that stood unrivaled until the mortgage meltdown nearly took out the whole global economy with it.
BREAKING DOWN October Effect
The October effect is overrated. Despite the dark titles, this seeming concentration of days is not statistically significant. In fact, September has more historical down months than October. From a historical perspective, October has marked the end of more bear markets than it has acted as the beginning. This puts October in an interesting perspective for contrarian buying. If investors tend to see a month negatively, it will create opportunities to buy during that month. However, the end of the October effect, if it ever was a market force, is already at hand.
What is true is that October has traditionally been the most volatile month for stocks. According to research from LPL Financial, there are more 1 percent or larger swings in October in the S&P 500 than any other month in history dating back to 1950. Some of that can be attributed to the fact that October precedes elections in early November in the U.S., every other year.
The End of the October Effect
The numbers don't support the October effect. Some historical events have fallen in the month of October, but they have mostly stuck around in the collective memory because Black Monday sounds ominous. Many investors today have a better memory of the dotcom crash and the 2008-09 financial crisis, yet none of those days were given the black moniker to bear for their particular month. The Lehman's collapse happened on a Monday in September and marked a large increase in the global stakes of the financial crisis, but it didn't get reported as a new Black Monday. For whatever reason, the media no longer leads with black days and Wall Street doesn't seem eager to revive the practice either.
Moreover, an increasingly global pool of investors don't have the same historical perspective when it comes to the calendar. The end of the October effect was inevitable, as it was mostly a gut feeling mixed with a few random chances to create a myth. In a way, this is unfortunate, as it would be wonderful for investors if financial disasters, panics and crashes chose to occur only on one month of the year.