Magic art of reading early market signs

After four days of trading in 1995, the course of the stock market over the next year may already have been set in stone. Some investors believe the first few days, hours, or even minutes determine the direction of the next 12 months. So you may a s wellknow the worst.

For those who believe the first three hours of trading indicate the market's movement for the rest of the year, the omens were bad. The FT-SE 100 index began falling almost from the moment the market opened last Tuesday. Followers of the three-hour rule will, presumably, be taking up a defensive investment position.

Unless, of course, they were watching the All-share index, which started off by rising - though in reality there is negligible statistical evidence for this particular theory.

But the the old saw that "As January goes, so goes the year" is broadly true - if, that is, you know how to read the signs. The statistician David Schwartz, author of the Stock Market Handbook, claims he does.

So far the signs look good. Prices in January are more likely to rise than to fall, but that does not mean the market will rise for the rest of the year. The rule is more complex. As long as the market in January does not fall by more than 1.91 per cent or rise by more than 3.65 per cent during the month, there is an 80 per cent chance that the it will rise over the ensuing 11 months. At any rate, that maxim has held true since the First World War.

By last Friday evening, the FT-SE 100 index was down by a mere 0.5 points, while the All-share index was down by a little over 15. If the market continues to drift for the rest of January, it may yet remain within the crucial band that indicates a year of rising share prices.

Warning signals only start flashing if there is a stronger move up or down in the month. This would mean prices are far more likely to fall during the year overall - which explains why 1994 prices fell even though there was a 4 per cent rise in January (that is, more than the 3.65 per cent upper limit).

This naturally raises the question, why? "I haven't the faintest idea," Mr Schwartz admits. "It works, that's all." To others, it is simply a matter of coincidence.

In the US, the "January barometer" is even more reliable than in London. Between 1950 and 1985, acording to Yale-Hirsch, a US investment research team, it has worked 85 per cent of the time thanks to factors such as January being the start of the new US tax year.

"When the track record is that strong, the rule should certainly be taken into account," says Bob Beckman, the Monte Carlo-based investment adviser.

But while the barometer works in both London and New York, the so-called "January Early Warning System" only works in the US. The early warning system claims that, in theory, the first five trading days of the year show how January as a whole will go.

After four days this year, it looks as if the Dow Jones index is fairly flat, which suggests a relatively poor year for US share prices. However, if the index ends marginally up by tomorrow evening and then falls to a loss by the end of the month, we arein for a serious bear market.

Unfortunately, when you apply the early warning system to London it is useless. "I can't find anything showing that the first week indicates how the year will go," Mr Schwartz admits. Over the last 10 years, for instance, it has worked exactly 50 per cent of the time - which, nonetheless, is rather more successful than many professional investors have been over the same period.

But even if you cannot find enlightenment in last week's trading, there are plenty of other indicators to look at, one of which is bound to support the view you already hold.

For instance, if you are an optimist about 1995, then look at the leap-year rule. It says that this year will be profitable. Since 1951, the year before a leap year has always seen a rising market (the reason, says Mr Schwartz, is probably to do with thetiming of US presidential elections). Even 1987 showed a small share price increase despite the stock market crash. Next year, of course, will be a leap year.

The "middle year of the decade rule" backs up this conclusion - at least on Wall Street. Since 1885, share prices have risen in every year ending with a five. There have been no exceptions.

Is this coincidence or some profound truth about the financial markets? Will 1995 be a bumper year or one to stay out of the market? You decide.