Sponsored Link:

Federal Reserve Interest Rates

The Smart Profits Report: Issue #391
Wednesday, January 31, 2007

Federal Reserve Interest Rates: How To Prepare For A Potential Price Shock
By D.R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

This Sunday, the Super Bowl will attract more television viewers than any other broadcast this year. But as usual, there’s almost as much hype about the commercials as there is about the game itself. And with so many eyeballs glued to the screen on Sunday evening, the going rate for a 30-second ad spot is $2.6 million.

The media buzz surrounding the Super Bowl commercials reminded me about one of the most well-known financial commercials - and how it relates to another important Federal Reserve interest rates announcement coming at 2:15 P.M. tomorrow…

A Collective Cupping Of Ears

Picture the scene: Two businessmen are sitting in a posh restaurant discussing the markets. The first renders his opinion about market direction, with the second guy chiming in: “Well my broker is EF Hutton, and EF Hutton says…” The camera pans back, and we see everyone in the restaurant - from patrons, to the busboy, to the kitchen staff - stopping what they’re doing, leaning toward the EF Hutton client, and cupping their ears so they can hear the market wisdom from this hallowed firm.

Although EF Hutton folded in the aftermath of the October 1987 stock market crash, the ad was a great success. And tomorrow - just like in that commercial - the financial world will stop and listen intently to what the Fed has to say.

But the big question is: Should you change what you’re doing with your trading and investing when the Fed gets set to make an announcement about interest rates? Let’s see…

When The Fed Moves, Markets Move

Eight times a year, the Federal Open Market Committee (FOMC) meets to determine its monetary policy for the coming weeks. And the group has some serious tools at its disposal. This includes:

  • How much money the bank should print
  • How many U.S. Treasury securities to sell.
  • The reserve requirement for banks.
  • What discount rate to charge commercial banks.

It’s this last point that captures the imagination of the public most often - because it’s the most tangible and has the biggest near-term effect on the markets. So what do the bankers have in store for today?

Much Ado About Nothing?

Because we’ve become a “Fed-watching” nation, there’s always much made about whatever the Fed does. But today, there’s very little chance that the Fed will actually do anything, keeping interest rates unchanged at 5.25%.

Some people say this is much ado about nothing. But oftentimes, it’s not so much what the Fed does that’s most important - it’s what the bankers say instead.

Specifically, economists and investors will be watching for comments about inflation to see if they can discern any hints as to future Fed policy direction. And Federal Reserve interest rate announcements do move markets. So we need to have a plan for how to address these scheduled events.

Let’s look at how short, intermediate and long-term traders might approach the Fed monetary policy announcements…

A “Fed-Focused” Investment Plan

  • If You’re A Short-Term Trader Or Day Trader: If you have positions that you hold for 48 hours or less, the Fed announcement is very important and could be critical. Even the most benign announcements significantly increase volatility on today. In general, the best strategy for short-term traders is to be out of the markets during times of known price shocks.
  • If You’re An Intermediate-Term Or Swing Trader: If you’ve entered a trade and expect to be in it for a couple of weeks to a couple of months, then a Fed announcement alone shouldn’t be the sole reason for jumping out of it. But if you’re close to your exit point, or anticipate a new entry point at the time of a Fed announcement, you might consider getting out a day early, or delaying entry by a day, so that you don’t get caught on the wrong side of a market reaction to the Fed announcement.
  • If You’re A Longer-Term Trader: If you’re holding positions for several months or several years, then the price shock that comes from a Fed announcement is more of a nuisance than anything else. For long-term investors, the only consideration might be to not enter a new position on the day of a Fed announcement, since it could send you in the wrong direction quickly.

In general, although Fed monetary policy announcements occasionally have a big impact, they’re usually minor market disruptions. They’re really much more important for the financial media than for traders and investors. But having a prudent plan for handling these periodic price upsets can add to your bottom line.

Great trading,

D. R. Barton, Jr.

Sign Up for The Smart Profits e-Report!

Today’s Smart Profits Cribsheet

  • As earnings season continues with a vengeance, it’s easy for rookie investors get caught in the crossfire of unpredictable moves. Whether it’s the post-earnings release selloff, or the “overnight gap,” price shocks are one of the most difficult events to handle. But there are three ways you can combat this. Find out what they are in Smart Profits #359, Price Shock: How To Respond To Three Types Of Price Shock During Earnings Season.
  • Pundits and investors are salivating… believing that good news on one or both of a couple key looming events will be enough to send the market soaring skyward. But watch out. History tells a different story in Smart Profits #335, The Stock Market’s Reaction to Good News: Why It’s Best to Sell at the Sound of the Trumpets.
  • Mt. Vernon Research’s own Technical AnalystJim Stanton will agree that technical indicators can provide some valuable clues in picking the right time to go against the crowd. A contrarian investing strategy can prove quite rewarding, to learn more visit Smart Profits #384, Contrarian Investing Strategy: The Most Profitable Way To Invest In 2007.

Related Articles:

The Chart Of The Week

Qualcomm (Nasdaq: QCOM) lacking volatility

Qualcomm (Nasdaq: QCOM) is traditionally a very volatile stock. But for the last five months, it’s traded in a well-defined channel, and volatility has been contracting. A breakout or breakdown outside of the channel is usually much more significant after such a severe drop in volatility.

Smart Profits Report Archives

Sphere: Related Content

Written by admin · Filed Under 2007 

Comments

Comments are closed.