Source: Economic Events Calendar 30 October 2019 - Admiral Markets' Forex Calendar
On Wednesday October 30, the FED will announce their interest rate decision. Currently market participants expect the third 25 basis point rate cut this year with a likelihood of around 90%, according to the FED Watch Tool.
The market is particularly confident of this announcement after the comments from FED chairman Jay Powell on October 8 in Denver where he said that the FED would resume Asset Purchases to prevent a cash crunch in money markets ( officially announced on October 11).
The FED can also be expected to be quite dovish at this meeting, even if, as Powell argued, these actions differ from crisis-era programmes, since they are directed at solving "recent tech issues" rather than materially affecting "stance of monetary policy" (thus it isn't technical quantitative easing.)
That leaves us with the following question: "Is there a chance to trade the FED statement in any direction, before, during, 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 it's 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 only invested on eight days a year.
What is particularly interesting: it didn't matter if the Fed 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 does such a simple strategy work 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 to make statements, give interviews or make 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 a risk event like a FED rate decision, these market participants tend to reduce their risk exposure, and rebuild it after the rate decision. So, once the "blackout period" begins, they 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:
- We enter a long position in the SP500 CFD on Tuesday, October 29, 2019 at 19:00 CET, regardless of the price at this time.
- A big disadvantage of the strategy is that it usually works without a Stop Loss. Since working with no clearly defined risk is not an 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 the average daily trading range of the last 10 trading days.
- The Daily ATR(14) reads ~44 points while the average daily trading range of the last 10 trading days has been ~50 points.
- Therefore, our worst case stop should be in the range between 45 to 50 points from our entry point in 1.
- We exit the Long position in the SP500 CFD on Wednesday, October 30, 2019 at 18:55 CET 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 26 2018 to October 25, 2019). Accessed: October 25, 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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