From the February 01, 2008 issue of Futures Magazine • Subscribe!

Find a top of the morning set-up

The U.S. Treasury futures is an often overlooked market. Most traders – novice and professional alike – look at the grinding nature of the trade and assume there is no trade there. In fact, the bonds are a tremendous trade, and at $31.25 per tick give you a lot of bang for your buck. But the best thing about the bonds is that they respond — and have responded for more than 20 years — to specific setups that will allow the novice trader to begin the path to profitability while trading without emotion; and provide the professional trader with more tools to use to win in the markets.

One successful set-up is called “the first-hour trade.” This trade is perfect for both the part-time trader who has a full-time career and the professional trader who trades the entire trading day.

The bond market opens in the pit at 7:20 a.m. CST. Wait until 8:20 a.m. CST and then record the pit high and the pit low for the first hour. The pit trade is a much better indicator of true price action (most charting packages give you the ability to filter your charts to pit only, electronic only or combined).

If the range for the first hour is 13 ticks or less, look for a breakout trade that will trigger either one tick above or one tick below the first hour’s range. The target for the trade is to double the first hour’s range.

In “One-hour breakout,” note that the bond market’s first hour range was 116-12 to 116-18. Once that range is set up, put in entry stops to buy at 116-19 or sell at 116-11. On Nov. 23, you didn’t have to wait long for the market to make your decision; at 8:30, the bond market went 18-bid and traded up to 20 – allowing you to get filled on your entry stop at 19. As soon as you are filled, immediately place your exit orders in the order book at the target price: 116-24 (A six-tick first hour range projects to a six tick extension; 116-18 + 6/32 = 116-24). The setup says the market should print the target price – not necessarily trade it - so you want to get your exit orders in fast so you are first in the queue.

Common questions about this setup are:

“Do we need to wait a few ticks after the breakout so we know it is not a false breakout?” No. Enter the trade at the breakout price, which is one tick above/below the first hour range. This way you can earn positive slippage if it retreats.

“What if the breakout doesn’t happen for a few hours?” As long as the trade can be expected to complete before the 2 p.m. pit close, it does not matter when the breakout occurs.

“Where is my stop?” This question can only be answered by the trader. Typically T-bonds require at least a three-tick stop – but no more than a five-tick stop. Place a stop you are comfortable with, and let the trade play itself out.

In entering this trade it is helpful to try and time your entry. In the above example, we are supposed to buy 19s. When the market is 18-bid/19-offer, pay closer attention, but do not buy when it is still 19-offer. When the market goes 19-bid you still do not have to bite, but do not miss the 20s. What dynamic you are exploiting is the grinding nature of the bond market that most traders dismiss as “poor trade.” The bonds do chop and grind, but this will inevitably mean they’ll come back 19-offer and when they go bid the second time and begin to fill in some bid volume (300-400), join the bid. It is an affective way to trade but if you can’t spend seven hours a day in front of your screen you can still use this strategy. A part-time trader can check the market at 8:20 a.m., place a stop order to initiate a position at the breakout price, place an OCO (one cancels other) stop/exit order – and turn off the computer.

This is only one of many useful setups in the T-bond market. While the pros reading this will have another trade to put on, the new traders must also realize the hidden benefit to trading setups like this: They give you entry prices and targets and remove your emotions from the trade.

Jack Broz trades bonds and mini-Dow from the trading floor of the Chicago Board of Trade where he has been a member since 1996. He can be reached at tttdow@themarlinletter.com.

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