Trading the FOMC

Hey Folks:

For those who might want to trade the FOMC. There is a simple way to approach it.

First you probably should get a little background on the meeting

Here is a reference

http://www.federalreserve.gov/FOMC/

You can use the calendar feature at the bottom of that page to look up past and future meeting dates.

what you should want to do is to be able to pull up historical data for the market you trade.

In my case, I trade the Russell contract primarily. So I will use the most recent meeting date and the intraday chart that goes with it

THE CONCEPT

What you want to do is to look at the size of the move from start to finish.

Here is the Russell chart for the most recent previous meeting on December 13, 2005

 

As you can see the move is broken down into parts.

1. The initial spike which is a kneejerk reaction to the news
2. The initial pullback as late arrivals decide what to do
3. The main move as traders jump on
4. The reaction move

The total size of the move was about 7 points in the Russell contract

 

Now what I do is to analyze this data by looking at:

What preceeds the move (The fakeout move)

What constitutes the move (The "parts" of the move)

and the magnitude of the move (absolute size of the move)

What you can do is to compare this move's characteristics to previous moves where the news is similar

Then you decide on a scenario

1. What will the content of the news be (rates up/down/same
2. What will the content of the meeting announcement be
3. How will the content of the meeting announcement affect the
move?

I create several (two or more) scenarios and decide in advance how to react to the action

 

Thanks Steve, Great information.

 

Trading the actual move

There are a couple of ways to trade the actual move

1. You can try to hit the spike move if you are confident that you know how it will go (I don't recommend it)
2. You can place a limit order above and below the market trying to catch the reversal move back down (I favor this strategy)
3. You can wait for the first pullback, and hit that price hoping to get the continuation move.

Strategy #1 is most risky and is better played with options over a longer time frame.

Strategy #2 was made famous by Steve Cohen and works IF you have good execution skills, experience and discipline to use it.

Strategy #3 was made famous by Linda Raschke. Essentially she suggests that anytime you have a momentum move (an impulse move) you should buy/sell the first pullback.

 

Now for anyone who wants to get into this what I suggest you do is to go back in your historical data and look at how price acted on each previous meeting date.

Compare that with the announcement news and you can start to develop scenarios for yourself

The next step is to papertrade the scenarios at each new meeting.

In the end you have to give it a whirl. But first analyze the risk involved in your market. What is your max loss is you are wrong and you cannot get out quickly?

Analysis of the after effects of the trade also helps you to become more comfortable. Take a look at what happens after the announcement. One day later, two days later, etc.

This will help you decide how to play the game.

Feel free to pm or respond here with additional questions.

Steve

 

Here is Pekelo's rule of trading the FOMC:

Wait a full 5 minutes after the announcement and jump on the direction whatever it is then. This usually works about 80% of the time....

 

Wait a few seconds before the announcement, put in a stop above and below market and fasten your seatbelt - better on 50/50 uncertain rate moves rather than statement analysis

On a more practical note Fed watcher Beckner says look out for a change to "some further measured firming "may" be needed" rather than "is likely to be needed"

 

OK, but how does that help us to manage risk?

 

I usually watch the ER2 minute by minute and as soon as the announcement is made, I go long or short the market spike in w hichever direction it is going adding contracts on the way up or down and then start pulling out in pieces. Nothing fancy of course but it has allowed me to grab the meat of the move in the middle on the spike. I try and leave some on the table instead of closing out the rest so I can ride what ever continuation move there is with an exit at the initial entry of the first trade.