Stock prices are determined primarily based on demand and supply. Stock prices determine the major part of returns. There does not exist any matrix that accurately tells the quantum of stock returns. However, there are plenty of factors that investors can consider to at least predict whether the stock will go up or down. The fundamental factors driving the stock returns are favourable news about the company, dividend announcements, P/E ratio earnings Per Share, etc.
However, some investors attempt to predict the price movements based on historical price data. They consider the non-fundamental factors whose impact on stock movement is difficult to explain such as the first day of month effect, January effect, weekend effect, etc.
This article highlights the weekend effect meaning, the weekend effect in the Indian stock market, why it exists, and what is the reverse weekend effect.
Weekend Effect
The stock market is considered most efficient when the stock price reflect all possible information. If the market is highly efficient, the possibility of beating the market is eliminated. When the market follows a random walk and does not reflect all possible information, the market is considered weak. In a weak market, prices move randomly.
The existence of Seasonality can reduce or eliminate this weakness. Seasonality in the stock market refers to the propensity of stocks to perform well sometimes, while poorly in others. Most stock markets fluctuate in a seasonal pattern. This implies that stock tends to perform well, at a particular time in the day, a day in the week, or a week in the month, as compared to other periods. This makes it possible to predict prices based on past data. The seasonality resonates with the weekend effect.
The Weekend Effect, an observed phenomenon in the stock market, implies that stock returns on Mondays are lower than that of the previous Friday. Stock prices do not necessarily move based on days. Though, historically, the stocks tend to perform better on Fridays than on the upcoming Mondays. This also suggests that Weekends, the non-trading days, can highly impact the stock performance on Monday.
For short-term traders, Fridays are usually considered good for selling the stock. For buying stocks, Fridays aren’t preferable as prices tend to be high. Mondays usually have lower stock prices historically. Therefore, some traders prefer to buy stock on Monday.
The Weekend effect is also sometimes referred to as the Monday effect. However, the term ‘Monday effect’ suggests that the stock prices on Monday's opening will follow the same direction as on the previous closing on Friday, i.e, If the market closed with an uptrend on Friday, Monday will open with an uptrend and vice versa.
Weekend Effect on Indian Stock Market
Many researchers from India attempted to assess the presence of the weekend effect in the Indian stock market. Majorly, the studies aimed at large-cap indices and stocks. Though some studies were focused on mid-cap and small-cap indices as well as stocks.
Some researchers found the existence of the weekend effect, whereas some found that there are no such shreds of evidence of the weekend effect in the Indian stock market. Therefore, the existence and degree of the weekend effect in the Indian market are still unclear. Moreover, it implies that it is not advisable to predict the market solely based on historical data.
Why Does the Weekend Effect Exist?
According to the ‘the behaviour of stock prices on Fridays and Mondays’ article published in the Financial Analysts Journal, the average return on Fridays is more than the next Mondays. In other words, Mondays usually have lower stock prices than immediate previous Fridays. This means the average return from Friday to Monday is lower.
One of the factors driving the stock prices is the investor’s behaviour. Due to higher uncertainty, investors often make panic trading decisions, rather than rational decisions. Therefore, the capital market significantly reflects the irrationality of investors. If there is bad news in the market, on previous days, a large number of traders and investors sell stocks on Monday, pushing the prices down.
Some financial theories also state that companies try to release bad news after the market closes on Friday. Investors, as a reaction to the bad news, push the prices down on Monday. Some theories also argue that the Weekend effect is the result of short selling.
However, some are skeptical whether this weekend effect ever existed while some believe that this weekend effect faded over years.
What is the Reverse Weekend Effect?
Contrary to the weekend effect, some of the research shows that returns on Monday are higher as compared to other weekdays. Some researchers also signify the occurrence of multiple Weekend effects based on the firm size. This means large companies tend to offer higher returns, whereas small companies provide investors with smaller returns on Monday. However, the reverse weekend effect is believed to exist only in the U.S. Stock market.
To conclude, the weekend effect is a non-fundamental phenomenon observed in the stock market which suggests the returns on Mondays are lower than on previous Fridays. Some of the reasons seem to be panic trading behaviour, short-selling, companies’ tendency to announce bad news on Fridays after market close, etc. However, the fact to be remembered is that the stock prices do not necessarily move based on days. An investor should not trade solely based on non-fundamental factors like the weekend effect.
