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Trading the Fed rate decision on the S&P500

September 18, 2019 11:00

Source: Economic Events Calendar September 18, 2019 - Admiral Markets' Forex Calendar

On Wednesday, September 18, the rate decision of the Fed will take place. And as already shown by July 31, this rate decision is a potential market mover, even though market participants expect the Fed to cut rates by 25 basis points with a chance of more than 90% based on the Fed Watch Tool.

So, markets have most likely fully priced in such a step, so the main question is mainly: what will the Fed deliver rhetorically, especially after the latest attacks from Donald Trump and next wave of escalation in the trade dispute between the US and China.

But, while analysts wonder about the next monetary policy steps and how the US central bank will anticipate a potential US economic downturn, the question from traders is: is there a chance to somehow trade the Fed statement in any direction, before and/or during and/or after the rate decision?

The Pre-FOMC Announcement Drift

The answer is: "Yes". In fact, several studies show that a strategy called the 'Pre-FOMC Announcement Drift' has been successful since 1980 and the profitability has even intensified over the last years.

In particular, when the US yield curve flattened out (right now, the 2-10-year US yield curve finds itself in the region around its flattest levels since 2007 with an even inverse structure) and the volatility in US equities (measured via the VIX) was relatively high, the 24 hours prior to the FOMC announcement could have been traded very profitably.

On average, nearly 80% of all profits in the S&P500 were made within eight days leading up to the interest rate decision.

In other words: if you bought the S&P500 just 24 hours before the FOMC announcement, you would have earned around 80% of the income of a buy-and-hold investor, but at a much lower risk because you were invested only on 8 days a year.

What is particularly interesting: it didn't matter if the Fed has raised or cut interest rates. The actual interest rate decision brought no overall return. The effect performance-wise was zero in total.

It seems as if the anticipation of an equity-markets-friendly decision of the Fed was of higher importance.

Why is such a simple strategy working so well?

First of all, the reason seems to be found in the fact that In the week before the Fed decision, there is a so-called "blackout period". That means, that voting FOMC members are not allowed any statements, give interviews or speeches which usually results in a drop in trading volume and liquidity thins out, putting it below average.

Secondly, professional investors have usually a risk-overweight in their portfolio. Before such a risk event like a Fed rate decision, these market participants tend to reduce their risk exposure, rebuild it after the rate decision. So, once the "blackout period" begins, the reduce their engagements and instead buy insurance for their portfolios via futures and options. Due to the low liquidity in the markets during that period, small purchases of equities result in a drift higher in equity markets.

How to Trade The Pre-FOMC Announcement Drift

But now the interesting question: how can we trade this?

We will use the following plan:

  1. We enter a long position in the SP500 CFD on Tuesday, 17th of September 2019 at 20:00 CEST 'Market' at the respective price at this time.
  2. A big disadvantage of the strategy is that it usually works without a Stop Loss. Since working with no clearly defined risk is no option for us as professional traders, we want to work with a worst-case stop based on volatility.

    Therefore, we look at the Daily chart in the SP500 CFD, the indicator ATR(14) and at the average daily trading range of the last 10 trading days.

    >The Daily ATR(14) reads ~37 points while the average daily trading range of the last 10 trading days has been ~20 points, too.
    .Therefore, our worst case stop should be in the range between 25 to 30 points from our entry point in 1.
  3. We exit the Long position in the SP500 CFD on Wednesday, 18th of September 2019 at 19:55 CEST if it is not stopped out before.

Source: Admiral Markets MT5 with MT5-SE Add-on SP500 CFD Hourly chart (between August 30, to September 13, 2019). Accessed: September 13, 2019, at 10:00pm GMT - Please note: Past performance is not a reliable indicator of future results, or future performance.

In 2014, the value of the SP500 CFD increased by 11.39%, in 2015, it fell by -0.73%, in 2016, it increased by 9.54%, in 2017, it increased by 19.42%, in 2018, it fell by -6.24%, meaning that after five years, it was up by 36.8%.

Source: Admiral Markets MT5 with MT5-SE Add-on SP500 CFD Daily chart (between July 14, 2018, to September 13, 2019). Accessed: September 13, 2019, at 10:00pm GMT

Check out Admiral Markets' most competitive conditions on the SP500 CFD and start trading on the SP500 CFD with a low 0.4 point spread. To test Admiral Markets DAX offering in combination with the described strategy above register for a free demo account today and experience the live market risk free!

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Disclaimer: The given data provides additional information regarding all analysis, estimates, prognosis, forecasts or other similar assessments or information (hereinafter "Analysis") published on the website of Admiral Markets. Before making any investment decisions please pay close attention to the following:

  1. This is a marketing communication. The analysis is published for informative purposes only and are in no way to be construed as investment advice or recommendation. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.
  2. Any investment decision is made by each client alone whereas Admiral Markets shall not be responsible for any loss or damage arising from any such decision, whether or not based on the Analysis.
  3. Each of the Analysis is prepared by an independent analyst (Jens Klatt, Professional Trader and Analyst, hereinafter "Author") based on the Author's personal estimations.
  4. To ensure that the interests of the clients would be protected and objectivity of the Analysis would not be damaged Admiral Markets has established relevant internal procedures for prevention and management of conflicts of interest.
  5. Whilst every reasonable effort is taken to ensure that all sources of the Analysis are reliable and that all information is presented, as much as possible, in an understandable, timely, precise and complete manner, Admiral Markets does not guarantee the accuracy or completeness of any information contained within the Analysis. The presented figures refer that refer to any past performance is not a reliable indicator of future results.
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