Monday, December 12, 2005

Fed Up on Fed Day

I'm taking a day off from exploring price change/momentum patterns in order to look at recent Fed announcement days. (See my Trading Markets article on the topic, which should appear Tuesday AM).

The gist of my findings is that Fed days no longer carry the volatility that they used to. The average daily range for the S&P from January, 2003 to November, 2005 has been 1.09%. On Fed days between January, 2003 and August, 2004, the average daily range has been 1.45%. Since September, 2004, however, the average daily range on Fed days has dropped to .90%.

Between January, 2003 and August, 2004, the average daily range was 1.26%; between September, 2004 and November, 2005, the average daily range has been .88%. Fed Days were modestly more volatile than average in the S&P prior to September, 2004; from that point forward, they were no different from the average market day.

This pattern is even more dramatic in the NASDAQ 100. Between 1/03 and 8/04, the average daily range was 1.83%. On Fed days, however, the average range was 2.31%. After 8/04, the average daily range for the NASDAQ has been 1.23%--but Fed days have only averaged 1.14%.
The same pattern occurs for both the Russell 2000 stocks and the S&P Midcap issues. Both indices were more volatile than average prior to September, 2004 on Fed days, but since that time, the Fed days have been no more volatile than average.

Here's another interesting pattern: Fed days tended to be up days prior to 9/04 (when they were more volatile), but have been down days on average since then. However, the three days following Fed days tended to be weak during the volatile times and recently have tended to be strong. The net message of this pattern is that, if the Fed does not produce a genuine surprise and policy change at its meeting, the intial market reaction to the report tends to reverse over the next three days.

I attribute the volatility change to the increasing transparency and gradualism at the Fed, which has reduced the number of surprises coming from the meetings. If the new Fed chairman continues these policies, we may see continued muted responses on Fed days.


Paulo de León said...

Brett nice articles about NQ trading and then AB trading. Now we can conclude that the AB has not experienced the same road as the NQ. Quoting again V. Niederhoffer about the law of conservation of energy, that states that the loss of energy in one market is gained in another. We can use the volatility measure as energy. Some lost energy in ES and NQ has been translated to the AB market, but not all of it; since the all stock markets has loss volatility. The question is relative to what? i can say now that after some research, the Euro market has gained volatility relative to ES. That research was very interesting to me and rises some remarks: a) when the US Stock market loss energy or volatility, the EURO has spike up in relative volatility. Particularly in very low periods of ES volatility as 1992-1994 and the present. b) i can guess (i have not tested yet) that other commodity markets has gained the energy transfer from Stock Markets, maybe gold and oil (further research is needed), or maybe the bond market c) all of this give me the idea that for a trader to diversify through markets the traditional concept of correlation maybe not the optimal. Traditionally, the coeficient of correlation is calculated using the move or direction of two markets. Low correlation markets are those that do not move together. It makes more sense to me to calculate the coeficient of correlation of the volatility of two mkts. to have a better measure of how volatility relares between markets. For example the correlation between ES and EURO in volatility is close to cero, correlation of move is negative for the period 1990-2005. The latter makes more sense for positional traders, not intraday or short term traders; and last d) another way of loss in energy is that the ratio bid - ask to Avg High Low has increased in recent years in ES and NQ making more costly, or in other way more portion of daily energy is lost in slippage and maintining the market´s operations.
tx for listening and sharing thoughts. Have a nice day or night.

Brett Steenbarger, Ph.D. said...

Hi Paulo,

Those are excellent observations. To the extent that fund managers and others seeking outperformance move money from one market to another to maximize returns, it makes sense that the loss of volatility ("energy") in one market would be absorbed in others. This fits well with Peter Steidlmayer's strategy of creating synthetic trading instruments that combine different tradeables and periodically reweight them to maximize trending, volatility, etc.