AM: How to trade the Fed

S&P500 daily at 1:31 EDT

AM Update

MARKET BEHAVIOR
Stocks are doing a lot of nothing leading up to the Fed’s 2pm Eastern policy statement.  We are in the middle of the recent range between 1600 and 1690 and there is plenty of room for the market to react without leaving the trading range.

MARKET SENTIMENT
Will the market really be surprised by anything the Fed has to say?  The Fed will most likely continue QE for the time being, but is looking for opportunities to scale back the program when the time is right.  Everyone knows and expects that statement, but it will obsess over every noun, verb, adjective, and preposition in the statement trying to sniff out any kind of clue indicating the tapering will occur sooner than previously expected.

But lets not make the mistake of assuming news drives the market.  This headline is simply an excuse for people to trade their dispositions and outlook.  If they fear QE ending, they are already out.  If they are indifferent to QE ending, they are committed to holding in spite of what the Fed has to say.  Some news based traders will try to get ahead of the next big move and will push the market one way or the other, but invariably the market will snap back because everyone is already positioned for their current outlook.  Once the news driven guys blow their load, there will be little follow on buying/selling to continue that move and it will stall.  At least that is the way it played out every other time over the last six-months.

The one exception is if the Fed is more decisive this time, either committing to massive QE through 2014, or alternately signaling tapering before the year is up.  These unexpected revelations are more likely to generate a directional and sustained move because it will change traders’ outlook on the future, leading them to adjust their portfolio to match their new view of the future.

TRADING OPPORTUNITIES
Expected Outcome:
Expect volatility to continue.  I would be tempted to fade the market’s initial reaction to the Fed.  If it is spooked, look for a bounce off of the 50dma or 1600.  If we surge, look for stalling around 1690.

Alternate Outcome:
If the Fed rocks the boat and startles the market with an unexpectedly bold policy statement, look for a lot of buying or selling by those on the wrong side of the trade.  It seems unlikely the Fed will be so brash given how measured they have been in the past, but we must expect the unexpected.

Trading Plan:
If the market’s initial reaction is making a big deal over nuance, fade the move when it approaches support or resistance.  If everyone is floored by the Fed’s comments, trade the ensuing stampede where people are changing their portfolio to match their new outlook on the future.  Markets only make sustained moves when people change their mind, so only make a directional trade if the news is converting bears or bulls to the other side.

Plan your trade; trade your plan