The U.S. Treasury bond market has been trading inversely to equities, which are being dragged lower by subprime lending issues and the related credit crunch. When the bonds rally as equity markets drop it is called a flight to quality, when it rallies along with equities it is believed to be following them. So, how do we identify market direction for the bond market? A few useful technical tools are chart patterns, trendlines (or speedlines), the 200-day moving average and 50% retracements of important moves.
In “Stacking bullish signals,” you can see how in June of 2007 (bottom left corner) bonds put in a low and then rallied to a high of 114.07 in early September. The 50% retracement of that rally was 110.15. The subsequent pullback in late September and retest in early October held above that price. That’s bullish. Now, note that the pullback and retest also formed three points of a triangle pattern. The sharp one-day rally in mid-October formed point four of the triangle and pushed bonds away from its 200-day moving average (the green line) that was minimally breached in the correction and retest of support. What followed was an upside breakout of the triangle. Note that the market is stacking bullish information on top of bullish information:
Held initial 50% retracement
Pushed away sharply off the 200-day moving average
Broke out to the upside of the triangle
The key is to try to stay long in this market. The market hit a high five days after the triangle breakout, and then started to sag back. The 50% retracement of the rally originating on point three of the triangle to that high was 112.11; note the pullback (October 30) held above that price. Bonds were still bullish. The subsequent rally took bonds up through the existing highs to near 119. The 50% retracement of that rally is 114.14; although that is useful to find direction, it’s too far away to be of any order-entry use. After the extreme volatility of Nov. 28-29, we drew in the first speedline (off the October low) touching the spike low made in mid-November and projected out to the current market. We drew a second speedline connecting the mid-November low to the Dec. 2 low. A break of those speedlines will be our first inkling that the bull run is over.
Jack Broz trades bonds and mini-Dow from the trading floor of the CBOT where he has been a member since 1996. Through his company, The Marlin Letter Inc. (www.themarlinletter.com), Jack advises, educates and mentors traders. He can be reached at firstname.lastname@example.org.