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.
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.
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.
US policy announcements affect share prices overseas too, with similar patterns materialising in the UK, Canada, Germany, Spain, France and Switzerland.