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Trading the 'Taper'

Trading the 'Taper'

James Stanley, Senior Strategist

Talking Points

- One of the most awaited-upon Fundamental Announcements of 2013 takes place on September 18th.

- The US Dollar may see massive volatility ahead of this well-awaited announcement.

- A way to trade these scenarios, when direction is unclear, but volatility looks promising

As markets across the world await the announcement from The Federal Reserve, one thing is certain. The US Dollar will probably see some volatility. Outside of that, there is much that remains in-the-air.

In this article, we’re going to go over some of the most popular potential outcomes and maybe even more importantly than that – we’re going to look at ways of trading the volatility from this news announcement regardless of what happens.

What is the Taper?

This has become a ‘hot-button’ word in the financial media of late, and the ‘taper’ is the prospect of The Federal Reserve beginning to decrease Quantitative Easing outlays.

Rounds one and two of QE were limited in scope. When those rounds of QE ran out, the Fed had to come up with additional policies to keep the global economy from collapsing. But when the 3rd round of QE was announced, and the 4th shortly thereafter – no limit was set, as they were designed to be open-ended programs that the Fed could modify as they saw fit.

At the June 18-19 FOMC meeting, Mr. Ben Bernanke announced that the Fed may look to begin tapering QE later in the year based on optimistic hopes of economic recovery. This created MASSIVE US Dollar strength (chart below).

The June 8-9 FOMC Meeting Created Massive USD Strength

Trading_The_Taper_body_Picture_3.png, Trading the 'Taper'

Created with Marketscope/Trading Station

On Wednesday, July 10th the minutes from that meeting were released to the public. The minutes showed that while the prospect of tapering QE purchases was on the table, many Fed officials wanted more assurance that the labor market was improving before beginning to taper stimulus.

This helped to create the opposite effect on the US Dollar, with massive weakness coming in the Greenback shortly after the release of the minutes.

USD Strength dissipated the market quickly after June Minutes were released

Trading_The_Taper_body_Picture_2.png, Trading the 'Taper'

Created with Marketscope/Trading Station

What has happened since the release of the June Minutes?

Markets have, essentially, attempted to anticipate the September FOMC meeting, as this was the first date on the calendar after Mr. Bernanke initially mentioned the prospect of tapering QE purchases.

September 18th has been circled on many traders’ calendars since Mr. Bernanke first mentioned tapering Asset Purchases, and tomorrow we will finally get to hear what the Fed is going to do.

What Potential Outcomes Might We See?

  1. The Fed announces the beginning of the QE taper. This will likely be by a small amount; a figure that has been thrown around after being first mentioned by Fed Vice-Chairwoman Ms. Janet Yellen is scaling back $15 Billion per month. This would mean a QE outlay of $70 Billion per month, as opposed to the $85 billion current allotment. This scenario would likely evoke a massive USD run of strength, and we may even begin to see safe-haven positioning from assets such as equities and fixed-income.
  2. The Fed announces that not enough information is available to decide to begin tapering. This would be similar to the verbiage of the Minutes that were released in July from the June meeting. This may provoke US Dollar weakness, but given that USD is sitting very near support already, any moves of weakness may be short lived as traders will, eventually, begin looking to factor in the inevitable taper.
  3. The Fed announces that economic weakness, or rather lack of strength, is such that they don’t want to yet plan when to begin tapering QE purchases, and that additional methods of easing will be investigated moving forward to supplement/replace current measures of liquidity.

This is the least likely of scenarios, but could amount to some very large moves in a very short period of time. In this scenario, US Dollars could weaken massively and currencies like the Euro, Aussie, and Kiwi see considerable strength.

What is the Best Way to Trade the September FOMC Announcement?

The one thing that traders know will probably happen tomorrow is that the US Dollar is likely going to move. While this may sound unsettling to new traders, given that nobody is quite yet sure of which direction the dollar may move; the fact that there is something to work with can be enough to build a strategy and a game plan.

In the article, The US Dollar Hedge, we looked at a strategy that seeks to capitalize on news announcements such as tomorrow’s FOMC or even the always-contentious Non-Farm Payrolls report.

In the strategy, the trader looks to take differing stances on the US Dollar in differing pairs; such as buying the dollar against a currency that has shown weakness, and selling the dollar against a currency that has shown strength; and looking to win one of the two trades. By using risk-reward ratios of 1-to-2 or greater, this could allow the trader a tidy net profit from the one winner that makes nearly twice what is lost on the one loser.

Taken from article, The US Dollar Hedge

Trading_The_Taper_body_The_US_Dollar_Hedge.png, Trading the 'Taper'

Created with Marketscope/Trading Station

With such a strategy, the trader doesn’t need to ‘hope’ that they guess the direction of the US Dollar before FOMC takes place, nor do they have to worry about getting in a trade while spreads are actively moving during the announcement itself.

For traders that are looking to trade the announcement itself, risk-reward ratios and proper money management are still of the upmost importance. In the article, Attacking News Events with Price Action, we look at a way of using Price Action to find risk-reward ratios that may be advantageous.

-- Written by James Stanley

James is available on Twitter @JStanleyFX

To join James Stanley’s distribution list, please click here.

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