The Federal Open Market Committee (FOMC) will announce its decision on interest rates on Wednesday at the end of a two-day meeting -- one that will be watched more closely than ever before. The financial markets have experienced incredible volatility over the last several months, almost disintegrating on several occasions. However, the Fed's string of interest rate cuts has managed to stabilize the situation, at least temporarily. Whether the market remains stable depends in good part on the Fed's next actions.

There is a general consensus, which I agree with, that the FOMC will cut both the short-term rates it controls -- the Fed Funds Rate and the Discount Rate -- by 0.25% and then indicate that it will pause in taking any further action at its next meeting. Given this consensus, the supporting statements the Fed issues will be what are truly important to investors. The devil, in this case, really is in the details.

In the past, the Bernanke Fed had a serious perception problem. Many investors thought that it was behind the curve, unable to stop a meltdown of the financial markets and a severe recession. The recent rate cuts and injection of liquidity through various lending facilities, along with facilitating the Bear Stearns sale, have eased the situation. Bernanke must be careful not to damage this newly found credibility in the upcoming FOMC statement.

What do investors want to hear this time? The Fed must be careful to emphasize that it will continue to deal with the credit crisis using other means, such as the Term Auction Facility (TAF), and that it is merely pausing temporarily and stands ready to move quickly with further rate cutting if the situation requires. It must not give any indication that it may get caught behind the curve again. Otherwise, it risks having the financial meltdown resume.

What implications does this have for the average investor? As I explain in my new book, Follow the Fed to Investment Success: The Effortless Strategy for Beating Wall Street, the key to investing based on FOMC decisions is watching real interest rates (interest rates adjusted for the rate of inflation). Negative real interest rates indicate a "loose" monetary policy and favor small cap stocks, and positive real interest rates indicate a "tight "monetary policy favoring large cap stocks like the S&P 500.

By switching between large cap stocks and small cap stocks following Fed action, you can outperform the S&P 500 by almost 3% with a substantially superior risk-return trade-off, my research has found. Since as many as 90% of mutual funds don't beat the S&P 500 over an extended period of time, this is a huge advantage for the individual investor. It has been tested back to 1928 before the Crash. It involves minimal work, requiring a trade every three-to-four years, and can be implemented using low-cost index funds. It allows you to have a life! And the beauty is that having this knowledge is just as valuable to the active investor as it is to those preferring to buy and hold.

Where are we now in this strategy? We have been in a large cap stock environment since the end of 2006 based on the Follow the Fed strategy. Incidentally, this would have minimized the damage to your portfolio because small cap stocks suffered most during the recent credit crisis. However, we are now beginning to experience a return to a negative real interest rate environment that favors small cap stocks. If the Fed's actions continue to favor this type of environment, and if the Fed can allay the current fear in the markets, small cap stocks may rally again. We will learn more on Wednesday after the FOMC statement is released.

Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on the stock prices, and is the author of Follow the Fed to Investment Success.