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Trader's Corner

You Had to Have a Microscope

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"You had to have a microscope to see any movement today," CNBC's Rick Santelli said a few seconds before the release of the FOMC's decision on Tuesday, December 12. Clearly, Santelli was addressing the bond market, because the equities, as evidenced by the SPX, had seen quite a bit of movement about noon.

Fifteen-Minute Chart of the SPX as the FOMC Decision Was Released:

Note: All charts in this article were snapped as the action was unfolding, with the possibilities discussed here also being decided as the action was unfolding. I wanted readers to see how they might have been looking at the action using formation and Keltner evidence, as well as historical patterns shortly before and after an FOMC decision. Recent articles have warned readers to be careful about trading immediately before and after the FOMC decision, because of the recent pattern established. That recent pattern included a pin-them-to-the-numbers effect heading into the decision, expanded volatility immediately afterwards, and then finally a settling into a recognizable pattern, typically a triangle.

About noon on Tuesday, two 15-minute candles broke the SPX down out of what had looked like a possible bull flag, dropping the SPX six points in thirty minutes.

This pattern was contrary to the typical pattern often seen on an FOMC day. The more typical pattern would have seen that first consolidation pattern continue into the release, with volatility then exploding before the volatility tamped down into a recognizable pattern. It was upon the break out of that post-decision pattern, usually a triangle with the break usually either at the end of the decision day on the FOMC meeting day or early the next morning, that the real move began. I'd written several articles warning that all but the most experienced and least risk-adverse traders should stay away from day trades the day of the meeting. I warned that the recent pattern had rewarded more conservative day traders--if that's not an oxymoron--who waited for that post-FOMC volatility to form into a recognizable pattern such as a triangle and then broke out of that pattern before initiating a trade.

Some of my articles mentioned the two risks involved in this tactic. One was the possibility of a good trade being missed ahead of the FOMC decision. Another was that even with all those safeguards of waiting until a triangle or other such formation set up after the decision, that the eventual break could be a fake-out move. Both risks were realized to some degree in this FOMC decision week.

About noon Tuesday, traders missed a good downside play. Or did they?

Annotated 15-Minute Chart of the SPX about Thirty Minutes Later:

Perhaps that lost opportunity for a good trade wasn't such a lost opportunity after all. Traders could have benefited, but only the quick and the adept, those who didn't need the advice on these pages anyway.

What about the tamping down of the post-FOMC volatility? Did that result in the setting up of a formation with defined support and resistance levels, one that could be watched for an upside break or a downside breakout?

Annotated 15-Minute Chart of the SPX:

Switching to a nested Keltner chart allowed a setting of potential targets, but showed a troubling possibility: the initial 15-minute movement could have met the initial upside objective. The possibility existed that the move was mostly concluded.

Annotated 15-Minute Chart of the SPX with nested Keltner Channels:

If that first 15-minute period had closed more strongly above the black channel line, a second upside target of 1422.55 would have been set, but that target could not be trusted to be met that day, given the effect of the black channel's resistance. Since resistance was essentially holding, Keltner evidence suggested that the SPX might need to drop back to the rising red channel line, at 1411.59 as this picture was snapped, but still rising steeply enough that it might be approaching the bull flag's former upper trendline by the time the SPX could drop back that far.

Annotated 15-Minute Chart of the SPX with Keltner Channels:

As the red trendline was hit, those adept at scalping could have entered long, but the first potential upside target that day was only 1415.31-1415.85. Also, unless RSI was going to trend at levels indicating overbought levels, as it of course can do, then it wasn't indicating a lot more upside potential. I think this is one post-FOMC day-trading setup that, while following the triangle-then-breakout pattern often seen post-decision, I wouldn't have suggested trading. I decided at this point to wait until the end of the day to snap another chart, to see whether that conclusion was a right or a wrong one.

Here's how the chart looked about 15 minutes before the close.

Annotated 15-Minute Chart of the SPX with Keltner Channels

Conclusions? Those who had adhered to warnings that the pre-FOMC period was not generally a good trading period for day traders perhaps missed a good scalping play, but they would have had to have been quick and lucky to benefit from that scalp that took place within the first 15 minutes of the trading day. Any hesitation would have turned a profitable scalp into a losing day trade.

The SPX did see volatility after the decision, volatility that settled into a triangle that was slightly more bullish than the neutral triangle often seen, but still met the typical post-FOMC pattern. Note: This conclusion about the triangle's bullishness comes because the ascending trendline had a sharper slope than did the descending one. This meant that there was a slight predisposition for prices to break to the upside.

Traders who gambled on that slight predisposition--something I probably wouldn't have recommended because the predisposition was only slight--and bought calls near the close on Wednesday would have been rewarded Thursday morning with a sharp move higher as the second triangle was broken to the upside, but day traders who tried to enter at the open would have been buying at expensive amateur-hour prices and would have needed to have exited quickly to have benefited from a day trade. Thursday was to be another day when the initial burst higher was going to produce the high of the day. Particularly in the case of those who bought front-month December calls, the rest of the day would have seen premium evaporate as the SPX spent the rest of the day forming another triangle.

Of course, the SPX went on break higher again Friday morning, with Friday morning's SPX settlement figure delighting December call buyers who had held through each morning burst higher and then narrowing range. Those who were swing trading, holding calls for several days, certainly benefited from each move.

For day traders, however, the setup hadn't been particularly good. I wanted to follow a potential trade as it was developing, adding in some other tools traders might use to determine whether that potential trade was likely to be a profitable one. The Keltner channel setup helped show that as a possibility.

The thrust of my original articles about the FOMC setup was to warn day traders to be careful about initiating trades in either that pre-FOMC period or the immediate post-decision period, not to advise them to enter trades on the breakout of the triangle that tended to form afterwards. There's a reason that's the thrust of these articles, and it has to do with the emails I typically receive just before an FOMC decision. As I've mentioned in other articles, I am no longer day trading, instead focusing on credit spreads, but I have received many emails from day traders who were trying to day trade the day of the FOMC meeting, before the announcement, and getting trapped in plays that were going nowhere. My goal was to illustrate that, for many FOMC decision days, that's exactly what can be expected.

This month's decision produced more pre-decision volatility than has been typical lately, but not a trade setup that was imminently more profitable except for those who were quick to move, both when entering and exiting. The same was true of the post-FOMC triangle and its upside breakout. Adding Keltner channels to gain a sense of where an upside target might have been set on any triangle breakout could have made day traders wary that the initial move could have been the only move for that day, as it was.

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