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Trader's Corner

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On Fed Watch

Several months ago, I cautioned short-term traders against entering a play just ahead of an FOMC meeting. The big-money contingent tended to pin indices ahead of such meetings. Option premium tended to evaporate as volatility eased and markets stalled. Indicators flattened, their signals no longer trustworthy.

Through various charts, an article illustrated that tendency. The charts also illustrated another phenomenon, this one often occurring after the FOMC decision and accompanying statement. Volatility often expanded after that announcement, with prices zigzagging above and below their pre-release levels, stopping out both bullish and bearish short-term traders. Often, however, that was the precursor to the setting up of a tradable formation, most typically a neutral triangle that broke either that afternoon or early the next morning.

Is that action still occurring? Another FOMC meeting approaches on December 12. It's time to determine if day traders should considering sitting out the day or two before the FOMC meeting and the immediate post-FOMC action, waiting until a recognizable formation sets up and price breaks out of that formation.

My current charting program does not allow me to look at intraday charts as far back as October 25, but I can examine the next-best period, the November 15 release of the October 25 minutes.

Annotated Three-Minute Chart of the SPX:

If the usual pattern was going to repeat, the next action would be post-release volatility followed by a settling down into a new, recognizable pattern. That pattern has most typically been a triangle, with prices breaking out of the triangle either late the day of the release or early the next morning.

After many FOMC meetings, the triangle that forms as the first post-meeting volatility is tamped down is a neutral triangle, but that wasn't to be true of the period after the release of the October 25 minutes on November 15. The triangle was to be a more bullish form of triangle.

Annotated Three-Minute Chart of the SPX:

Day traders would have wanted to see confirmation of any breakout by an RSI breakout to the topside, too.

The breakout was to occur by the end of the day on the 14th.

Annotated Three-Minute Chart of the SPX:

The upside target was not met, but the downside break did result in a six-point move.

Is the theory blown? I don't think so. Admittedly, the action was volatile the day before the release, but only in the morning. By the afternoon, prices had settled into a tight-ranged rising wedge that held until the release of the minutes. Tuesday, the 14th, had seen the release of the PPI, a key economic number for those on Fed watch, and that release might have triggered some of the volatility that normally would have occurred after the FOMC minutes had been released. The truth of the matter, too, is that the release of the minutes, while chosen as a proxy for the FOMC decision and statement, was not perhaps an authentic proxy.

However, I propose that the pattern did essentially assert itself. Beginning the afternoon before the release, prices did settle into a tight, hard-to-trade pattern. After the release, prices did show some volatility but then settle into a well-defined triangle, albeit a bullish right triangle rather than a neutral one.

In addition, all formations, including triangles, occasionally fail to produce the expected result. The ultimate failure of the upside breakout was perhaps predicted by the RSI action. RSI did not mimic the prices by settling into a bullish right triangle, but instead formed a neutral triangle, less bullish than the price pattern. RSI did not convincingly break to the upside out of its triangle, either, so did not convincingly confirm the price breakout. Any who entered long should have had tight stops beneath that bullish right triangle, and the adventurous might have switched sides there, entering to the downside with a six-point target.

Although the pattern wasn't perfect, perhaps the proxy status of the minutes wasn't either. With that caveat, it's my opinion that the pattern did repeat convincingly enough that I would suggest caution in entering new positions just ahead of the next FOMC meeting. I don't trade intraday moves any longer, but instead concentrate on credit spreads, so I won't be trading this setup myself, a disclaimer I want to make for those who want to trade only those setups that the writer trades. As I've mentioned in previous articles, I have many reasons for not trading these types of trades, including the health of a family member and the style of trading that best fits my needs right now.

The adventurous day trader who is determined to trade that week should perhaps again wait for the post-FOMC-announcement volatility to settle into a recognizable pattern and then watch for a break of that pattern, most typically a triangle. That break should be convincingly confirmed by RSI or CCI, in my opinion, and stops should remain tight.

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