The Federal Open Market Committee (FOMC) meetings, held by the United States Federal Reserve, have a significant impact on financial markets around the world. These events are closely watched by day traders, as they can present lucrative trading opportunities. To make the most of an FOMC market reaction, it is essential to understand the four distinct phases that typically occur during and after these meetings. Each phase requires a different approach and strategy to maximize trading success. In this article, we will delve into each phase and outline the recommended trader's approach. If you want to actively trade the FOMC reaction with us, join the Trader’s Thinktank with a 14-day trial by clicking here.
Phase 1: The Initial Kneejerk Algo-Driven Move on the Release
The first phase of an FOMC market reaction is characterized by a rapid and often volatile knee-jerk reaction following the release of the committee's decision on interest rates and accompanying statement. The initial reaction to FOMC is typically a fake out. Often times downside hedges are being removed and that can provide a bid. But that bid doesn't always last. During this phase, algorithmic trading systems dominate, causing significant price fluctuations within seconds. Traders should be prepared for swift market movements and heightened volatility.
Approach:
Monitor market sentiment and have your levels set and pre-determined. Levels should be areas that you are interested in watching price action to establish a trade. If you’re in the Trader’s Thinktank, watch the reaction versus the posted S1/S2/S3/R1/R2/R3 levels from the Premarket Prep notes.
Set up an appropriate trading plan: Once you have identified key support and resistance levels, visualize what you want to see when price tests those levels. Mentally rehearse potential entries based on your analysis.
Exercise caution: Given the increased volatility, it is advisable to reduce position sizes and avoid overtrading during this phase. Wait for the initial price action to settle before taking any significant positions. In the Thinktank, we usually do not trade the initial move. Much easier to let the dust settle and see how price develops.
Phase 2: Market Reaction to the Press Conference
Once the initial kneejerk reaction subsides, traders shift their attention to the press conference held by the FOMC chair. This phase offers additional insights into the committee's outlook, economic indicators, and potential policy shifts, providing traders with crucial information.
Note: Both Phase 1 and Phase 2 are notorious for high implied volatility in the near-term expiring options. This means you can be right on direction but still end up losing money if positioned incorrectly. Caution is warranted if trading options during this phase.
Approach:
Focus on price action: While the press conference is ongoing, unexpected comments from the Fed Chair can create big swings in price. Many traders claim that technical analysis does not work during these volatility events, but that could not be further from the truth.
Actively manage and keep hard stops: Adjust your trading positions accordingly. The key to success when trading through the press conference is to stay nimble. Secure quick gains with partial positions, have firm price targets based on the technical picture, use trailing stops, and have a hard stop if you are wrong on the idea.
Phase 3: “Cooler Heads” Reaction from 2:30 PM to the Close
After the initial market volatility and the press conference, a period of relative calm typically ensues. This phase, often characterized by cooler heads prevailing, allows traders to evaluate the FOMC's decision and the market's response more rationally.
Approach:
Assess the impact on market sentiment: Analyze the evolving market sentiment in response to the FOMC decision. Consider any nuances that may have emerged during the press conference and evaluate the overall reaction of market participants. The market can trend into the close following the press conference.
Review Higher Timeframes: Through the volatility, it’s easy to miss the forest for the trees. Multiple timeframe analysis and big-picture context are key during this period. Do a quick refresh of your charts to make sure you are aligning yourself with the big-picture setup. Utilize technical analysis to identify support and resistance levels and current market structure. This can provide valuable insights into potential price movements for the remainder of the trading day.
Execute well-planned trades: Based on your analysis, execute trades that align with your trading plan and risk management strategy. Maintain discipline and avoid impulsive decisions driven by short-term market noise. If you have missed most of the volatility, or perhaps failed to execute on your A+ setup during this time, it can be easy to feel like you are missing out (FOMO). FOMO can cause traders to act on impulse and take trades that aren’t within their system. If you feel FOMO, walk away.
Phase 4: Overnight/Next Day Reaction Based on Headlines
The final phase of an FOMC market reaction occurs overnight and extends into the next trading day. During this phase, market participants digest the FOMC decision and accompanying statements more thoroughly. Headlines from media outlets and financial analysts play a significant role in shaping market sentiment.
Approach:
Stay updated with news and analysis: Check the after-hours and pre-market action in SPY or ES. Have any of the key levels from the higher timeframe analysis been tested? Double check your playbook and mentally rehearse what the most likely play of the day is. It is important to know what type of trading day it is going to be. From this analysis, a game plan for the day can be developed.
Adapt your trading strategy: Based on overnight developments and your analysis, adapt your trading strategy for the trading session. Be prepared for potential continuation OR reversal of trends initiated during the previous phases.
Navigating the four phases of an FOMC market reaction requires a thoughtful and adaptable approach. Be prepared to stay nimble and avoid overstaying your welcome in any trade idea. If you are relatively new to trading (years 1-3), it is better off to avoid trading FOMC days. Day traders should be prepared for initial kneejerk reactions, closely analyze the press conference, evaluate market sentiment during the calmer phase, and stay updated with overnight developments. By understanding these phases and tailoring you strategies accordingly, you can enhance your chances of success and capitalize on the opportunities presented by FOMC meetings. During these high volatility events, remember that risk management should always remain a top priority.