Your 1-Day Trade for This Week’s Fed Meetings

Investor Insights:

After the July 31 Fed meeting, the Dow dropped almost 500 points in 18 minutes.
July 31 was a dramatic example. But big moves on Fed days are almost routine.
This simple strategy works for one day of trading every six weeks.

It was January 9, 1991.

I was deep underground, working in the Strategic Air Command headquarters. We awaited news on negotiations between the United States and Iraq.

Rumors were flying. We expected good news as Secretary of State James Baker walked to the microphone.

Baker’s first word was: “Regrettably…”

We knew war was inevitable.

I remember that day because I was watching the ticker cross the screen on Financial News Network as Baker spoke. This was before CNBC.

Listening to Baker, I saw stock prices plummet. That one word sent the Dow Jones Industrial Average down more than 1% in seconds.

Since then, I always watch stock prices when major news breaks.

It’s easy nowadays. CNBC and other traditional news networks show prices whenever the stock market is open.

Lately, news-related moves are predictable. And every six weeks, there’s a big move after the Federal Reserve meets.

Transparency Creates Volatility

Federal Reserve Chairman Jerome Powell holds a press conference after each meeting. This is a new development in Fed policy.

Chairman Ben Bernanke was the first Fed head to hold press conferences. He used them to calm investors during the financial crisis.

By explaining policy, the chairmen hope to avoid surprising investors. Unfortunately, sometimes their efforts increase volatility.

In June 2013, Bernanke experienced the “taper tantrum.” He said: “The committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.”

That meant the Fed would begin tapering the actions it took during the financial crisis that started five years earlier. It was a benign statement.

But traders sold bonds. Interest rates on 10-year Treasury notes jumped from 2.25% to 2.45% in hours. Typically, bonds move less than 0.1% in a day.

News-related moves are predictable. And every six weeks, there’s a big move after the Federal Reserve meets.

(Source: Federal Reserve Bank of St. Louis)

Bernanke quickly walked back his comments to assuage traders’ concerns. He also spoke cautiously in the rest of his term.

His successor, Janet Yellen, sat in a high-backed chair for her conferences and tried to speak informally. She was calming to traders.

The current chairman decided to increase the number of conferences. Powell speaks after every meeting, often sparking market reactions.

One recent example was his July 31 press conference.

The Fed cut rates at that meeting. Traders expected more cuts.

Powell said: “We’re thinking of it essentially as a midcycle adjustment to policy. I’m contrasting it there with the beginning of a lengthy cutting cycle.”

Traders thought this meant there would be no more cuts. The Dow dropped almost 500 points before recovering.

The Dow Fell 1.8% in 18 Minutes

News-related moves are predictable. And every six weeks, there’s a big move after the Federal Reserve meets.

A Pattern in the Market Action

July 31 was a dramatic example. But big moves on Fed days are almost routine.

In looking at previous press conferences, I noticed a pattern.

The popular moving average convergence/divergence (MACD) indicator tells me how to trade the day.

MACD is a momentum indicator. You can learn more about it by watching my video.

It’s a simple and useful indicator. I wrote about this trading tool last week when I showed another way to use it.

The rules for trading the Fed are simple:

If MACD is on a buy signal at the close the day before the press conference, buy the SPDR Dow Jones Industrial Average ETF (NYSE: DIA).
If MACD is on a sell signal at the close the day before the conference, buy the ProShares Short Dow30 (NYSE: DOG). This is an exchange-traded fund (ETF) that goes up on days the Dow goes down.

The chart below shows trade signals since Powell took over the Fed. Vertical lines mark Fed days.

MACD Signals for Fed Days

News-related moves are predictable. And every six weeks, there’s a big move after the Federal Reserve meets.

Powell has led 13 Fed meetings. MACD correctly forecast the day’s direction nine times (69.2%).

On average, this strategy resulted in a gain of 0.2% in one day. That’s 10 times the average daily gain for a buy-and-hold trade.

Another Way to Trade Fed Meetings

There’s a way to potentially turn small gains into larger ones, and limit potential losses, with options.

A call option gives the buyer the right, but not the obligation, to buy the ETF at a specified price at any time before the option expires. It increases in value when prices rise.

A put option gives the buyer the right, but not the obligation, to sell the ETF at a specified price at any time before the option expires. It increases in value when prices fall.

You won’t have to exercise the option to collect a gain. You could simply close the option with a sell order.

Options offer defined risks. You can never lose more than you paid for the option. This means risks are small in dollar terms since options usually trade for just a few hundred dollars or less.

For this Fed day trade, look at options on DIA: