Event Trading

The market hates uncertainty.  There is an edge that comes from that human tendency.  Whenever you go into a hyped up event (FOMC meeting, hyped up nonfarm payrolls/CPI data releases, earnings announcements, elections, etc.), there are patterns that emerge.  In order to predict how markets react around these events, you have to make a basic assumption.  The assumption is that active traders/investors are usually long financial assets.  Its rare for even hedge funds to be net short equity or bond exposure.  And long only funds cannot short.  I made a post about event trading several years ago and it still holds true. 

Let's go into how active investors/short term traders behave around an event.  

1. They often reduce their net exposure.  The more feared the event, the more exposure that is reduced.  Since they are almost always net long, it means they reduce their longs.  The result:  you often see a pullback ahead of an event, from several days before, for big events like an election, to just a few days before, for smaller, less feared events like economic data releases or FOMC meetings. 

2. Since investors and traders have already reduced their exposure ahead of the event, usually at least a day ahead of time, there is a lack of selling pressure from active traders right ahead of the event (a few hours ahead) and after the event.  This often explains the common upward drift ahead of FOMC/NFP/other hyped up event  for the few hours ahead of the release.  Here is a recent example: 

FOMC Meeting November 1 2023

3. The intermediate term trend (2 to 8 weeks) ahead of the event is usually resumed after the event.  The exceptions are very big events where investors AND traders prepare several weeks ahead of time (e.g.: Presidential elections).  In those cases, the long to intermediate term trend (3-6 months) is usually resumed after the event.  

FOMC Meeting May 4 2022 / CPI Release Sep. 13 2022

2020 Presidential Election November 4 2020

4. For most events, since active investors and traders have reduced their positions ahead of the event, after the event, you usually see a rally.  Especially when active investors and traders have been building up long positions in a rally for the previous month. 

5. In the long run, the market pays a risk premium to those that are willing to take on long exposure ahead of events, especially feared events.  That premium is usually paid out in the form of an immediate one day rally after the event, for economic data releases, or for several days after the event, for really big events like a 2020 Presidential election.  

We have a CPI release this morning and the "feared" 30 year Treasury auction at 1:00 PM ET.  Considering how bad the 3 and 10 year auctions went, expectations are low for the most important Treasury auction of the month.  Add to that, the FOMC meeting on Wednesday, and you have a slew of events that the market will be faced with.  Since we've had a strong uptrend in both stocks and bonds going into this week's events, its likely that they will rally after the FOMC meeting is behind us.  

Bigger picture, the SPX is in the middle of a late stage bull market rally where fundamentals are ignored and valuations are very high.  It presents a great opportunity for the short side in 2024.  For those inclined to play the short side, save your ammo and don't burn capital trying to play for a pullback.  Its not worth it to short it here, both from a seasonal perspective and a technical perspective.  The brutal selling in September and October needs to be completely forgotten and gone from the rear view mirror before the risk/reward for a short is compelling.  When the timing is ripe for a short, it will be a whopper of a short.  The potential energy building up on the short side is immense.  But if you short too early, you won't be able to hang on for the ride to the other side of the mountain.  I can't bring myself to chase longs in this bloated market even though I think it goes even higher.  I still see too many consistently wrong Fintwit posters skeptical about this rally. 

Probably will have to wait until March or April for the SPX to top out.  Until then, keep powder dry and protect capital.