There are significant short-term gains to be made in the stock markets by using a simple trading strategy based on monetary policy announcements from the US Federal Reserve.
The approach, which was proposed by researchers at the University of Notre Dame, could net investors a much greater return than any standard buy-and-hold strategy without exposing them to higher risk.
Surprising Gains
The researchers found gains of roughly 4.5% for investors who either bought or shorted in a 40-day window pre- and post-Federal Open Market Committee announcements which didn’t align with market expectations.
These “surprises” can yield strong gains for investors even if they have not taken up a position prior to the announcements being made.
It is routine for markets to forecast FOMC announcement content, and there is often a response when the Fed acts in contrast to what was predicted.
An announcement is defined as an expansionary surprise when the new target rate fails to meet market forecasts, and a contractionary one when it surpasses expectations.
Predictable Movements
Share prices are predictable both before and after either type of surprise – they will rise approximately 25 days before the announcement of an expansionary surprise for a gain of around 2.5%.Before a contractionary one, prices tend to fall.These movements are thought to affect every industry with the exception of the mining sector.
Over a period of 15 days, share prices are also seen following the same path, which leads to a difference of 4.5% between share prices following either type of surprise announcement.
International Ripples
US policy announcements affect share prices overseas too, with similar patterns materialising in the UK, Canada, Germany, Spain, France and Switzerland.