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Is There an Opportunity to Trade Around FED Meetings?
In this post, we will discuss an interesting phenomenon known as the "FED Day Effect." Buckle up because by the end of this discussion, you'll not only understand why Federal Open Market Committee meetings are pivotal but also how to leverage this knowledge to potentially improve your trading strategy.
Disclaimer: This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities.
All the concepts covered in this post are taken from the Quantra course on Event Driven Trading Strategies. You can preview the concepts taught in this course by clicking on the free preview button and going to Section 8 and Unit 1 of the course.
Note: The links in this tutorial will be accessible only after logging into quantra.quantinsti.com
What is “Fed Day”?
The Federal Open Market Committee (FOMC) meetings, occurring eight times a year, are like high-stakes gatherings where monetary policy, interest rates, and economic outlooks are on the agenda. But here's the crux: these meetings wield significant influence over the stock market. And we call the days on which this meeting takes place as “Fed day”.
The last 3 Fed meetings were held on 1st Nov 2023, 13th Dec 2023, and 31st Jan 2024 respectively. Let’s see the price of SPY (SPDR S&P 500 ETF) during these days:
The meetings held in November and December were accompanied by a rise in prices while the one held in January 2024 was accompanied by a decline in price. What does this tell us? This could mean that the Fed meetings do have an impact on the asset’s price.
Besides the three meetings outlined above, Fed meetings generally tend to have a positive impact, often resulting in price increases. However, there are a few odd instances where they may lead to price declines, as observed in January 2024.
But why do stocks tend to shine on FED days? It boils down to a fundamental rule: "Don't fight the FED." The Federal Reserve's primary mandate is to foster financial stability and economic growth. Consequently, FOMC decisions (on average) lean in favor of stock markets, acting as a tailwind for investors.
Can we create a strategy around this? Yes!
Let’s Talk Strategy
Entry rule:
Buy into the SPY (SPDR S&P 500 ETF) a day before the FOMC meeting
Exit rule:
Exit at the close of the meeting day.
This straightforward approach has demonstrated promise over the years. Since 1993, such a strategy would have nearly doubled your investment by 2019, resulting in an annual growth rate exceeding 2%. The presented strategy results are intended solely for educational purposes and should not be interpreted as investment advice. A comprehensive evaluation of the strategy across multiple parameters is necessary to assess its effectiveness.
Sure these numbers may not be very impressive but think about this: the strategy operates on a handful of days annually, which means your capital will not be locked for a long time and when it’s free you can use it for any other strategy of your choice.
It is important to note that backtesting results do not guarantee future performance. The presented strategy results are intended solely for educational purposes and should not be interpreted as investment advice. A comprehensive evaluation of the strategy across multiple parameters is necessary to assess its effectiveness.
You can learn all the steps to carry out this strategy from the video in the course Event Driven Trading Strategies.
Can we improve the strategy?
We can fine-tune this strategy even further by adding a trend-following filter. This means we only stay in the game if the index price is riding above its 200-day average. Translation? When the market takes a nosedive, our strategy takes a breather, shielding us from unnecessary losses. The result? A smoother ride with an even better performance-to-drawdown ratio.
Final Thoughts
Now, you might look at the numbers and think, "Hmm, I could do better." But bare in mind, we're not just chasing total returns here. We're crafting a piece of a larger puzzle—a composite strategy that's sturdy, reliable, and built for the long haul. In other words, this strategy should be combined with various other event driven strategies to create one reliable and sturdy strategy. So, while the performance of this standalone strategy might not be impressive at first glance, the potential for growth and resilience is what truly counts.
In this post, we have explained how the FOMC Meeting impacts the stock market and we’ve created a strategy around this impact. You can also learn more about the implementation of this strategy using Python. All you have to do is take a free preview of Section 8 Unit 5 of the “Event Driven Trading Strategies” course on Quantra.
What to do next?
- Go to this course
- Click on
- Go through 10-15% of course content
- Drop us your comments and queries on the community
About the Author of the Course
This course is co-authored by Quantpedia. Quantpedia is the database of quantitative and algorithmic trading strategies. It helps users in processing financial academic research into a more user-friendly form to help anyone who seeks new quantitative trading strategy ideas.
IMPORTANT DISCLAIMER: This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in financial markets involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication sent as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities or any other kind of asset.
