Wednesday, April 30, 2008

What A Strong Reaction To The Fed Could Lead To

Last month I presented historical returns following days when there was a strong reaction (+1%) to a Fed (pictured at right) announcement. The results showed that the positive reaction was typically short-lived. Another highly anticipated Fed announcement is due tomorrow. Tonight I thought I’d present historical returns following a disappointment (just in case).

As you can see, a strongly negative reaction to a Fed announcement has typically been followed by a very positive next two weeks. So…if the Fed does something the market “likes” it will go up tomorrow, but over the next two weeks returns will likely be disappointing. If the Fed disappoints the market tomorrow we’ll see afternoon weakness. This disappointment could lead to a nice rise over the next two weeks. So the bulls should want the Fed to upset them tomorrow, and the bears should hope for a short-covering rally.

I find these tendencies to be quite interesting. My untested (as of yet) theory on why this occurs is that “good” news normally will come in the form of a rate cut or other stimulus. This kind of good news happens during times of economic and market weakness and the improvement for both can take time. “Bad” or “disappointing” news many times will come in the form of tightening. The Fed tightens normally when the economy and markets are strong. Just as they can’t fix it in a day, they can’t break it in a day either. Their “bad” decision won’t derail a rally right away and the market will typically continue to trudge higher for a while.

Whatever the reason, the point to remember is this: Don’t get too caught up in the reaction to the Fed tomorrow. The move likely won’t last longer than a day or two before reversing itself.

Edit note: Test was run back to 1982.


Anonymous said...


your the man for putting a picture of k-fed up on fed day ! I love that humor ! Great blog

LP said...


Have you looked into these trades in the context of Bull and Bear markets? Or Up and Down trends? I wonder if it provides a larger edge.


Small Cap Slingshot said...

Nice post. This is exactly how I am going to play it. I am going to short a rally and buy a pullback. However, I do think that after the post-Fed dance is over, we may well continue on with this rally.

Small Cap Slingshot said...

I am also playing the Fed move itself. Since we have been creeping higher on lighter volume (including today), I feel that sell the news reaction is coming. Three hours and change to see if this was a good move.