Friday, October 30, 2009

Don't get technical with me! 10/30/09

I think whenever we are using technical analysis, we have to remember why it might work. Charts and patterns aren't some mystical energy field that controls the market's destiny. Its merely a means of gauging the market's mentality. Take a very simple indicator like the MACD, which is one I like a lot. All it basically shows is whether the 2 week moving average is lower or higher than the 1 month moving average. What does that tell you? Merely that price gains (or losses) are accelerating. In other words, is there momentum?

There is solid logic to the idea that stocks might follow a momentum-type pattern, that is that market participants won't all draw the same conclusion about a stock at the same time. Some will buy in early and some will buy in later. If IBM stock has positive momentum, maybe that means more and more people believe the company is executing on its strategy.

From a technical stand point, if positive momentum develops, that might be an indicator that some early adopters are buying the stock. You can buy in hoping that others will follow those early adopters.

This is a simple way of seeing how a chart can reveal something about how the fundamental side of the market is behaving. That is exactly where I think technicals can help one trade effectively. Often when I consider the fundamental picture, I can see good arguments on both sides. By using technicals, you can often find which argument is winning. This can help you better execute a fundamental view. If you want to be long, but see momentum building on the other side, perhaps its better to wait for another entry point.

One could say that technical analysis is trying to front-run fundamental investors. Momentum is one example, as illustrated above. Something like RSI is another. When a stock becomes over-bought, its logical to say that fundamental buyers may choose to take profits.

Where I think technical analysis breaks down is when it gets overly complicated and loses all connection with fundamentals. Elliot Waves, and seasonals are two that some immediately to mind. I roll my eyes whever I read something like "June and July have been good months for bonds 7 of the last 10 years."

Anyway, let's get to it. I've been touting 3.48% as a good support level for two weeks now, but it doesn't look as strong after having been broken materially.



In fact, it looks like a solid upward trend (in yield) has been formed. Here is the closing yield chart...


Looks like we need to hold around 3.45% to keep the trend in place. So 3.45% would be a good entry for a short, especially if we manage to close slightly higher than that today (in yield) today.

Here is the bar chart in price on the current 10s. I've tried to draw the lines between intra-day highs/lows (red) and the close high/lows (green).Confirms the yield chart, I think. And since I mentioned the MACD above, I figure I have to throw it in here. Momentum still sharply negative.



So I think you enter a short. If you want to be aggressive (which I am), do some at 3.45% if we hit it today, then add if we close at 3.46% or above. The stop would be if we close at 3.43% or lower yield, indicating that the trend might be broken.

30 comments:

In Debt We Trust said...

Isn't it dangerous to short bonds on Thurs-Friday b/c that's when the labor reports typically come out?

Flow5 said...

Seasonals? They provide an accurate way to trade markets, but not using percentages, not using the "January Stock Effect", not IBM's 4th qtr, not the FED's seasonal factors, not the "pegged" FFR.

The seasonal cycle is a sell or a buy depending upon whether the "trading desk" is "tight" or "easy" at specific times of the year, e.g., May 5th.

LB said...

Well, I enjoyed that piece of TA, it was well constructed, although it was obviously wrong. You can start all over again now based on yesterday's rally in the long end.

FWIW, I am bullish Treasuries into the end of the year based on seasonals, expectation of profit taking in HY and equities, apparent end of QE programs, unwind of the dollar carry trade and a resulting dollar rally - there is also a need for banks to clean up their balance sheets for EoY by replacing lower quality securities with Tsys.

Having said that, I did hedge with TBT on Friday, assuming that some of the rally was safety buying that will be unwound on Monday.

Overall I am less bearish on Tsys than you b/c I expect a somewhat deflationary environment to persist, for as long as housing and unemployment are weak (they will be) and savings likely to rise (they will certainly rise, sans cash for clunkers and other silliness). Any double-dip here is going to make buyers of the 10-yr at 4% look smart. We are more like Japan than people realize.

In Debt We Trust said...

After Friday's tandem bond rally and 6 pt vix gap up for equities (or roughly 24% - a level we haven't seen in some time), I would not be surprised to see some profit taking early next week from bond bulls.

Wednesday's FOMC statement is an opportunity to run a spread trade instead of placing a directional bet. B/c the initial reaction is seldom the correct one, what do you think about selling strangles?

Accrued Interest said...

Yeah, in the post I said we had to hold at 3.45% for a short to work, which we obviously did not. So I never actually put anything on.

getyourselfconnected said...

Wow, did you really meet with the Treasury!

Accrued Interest said...

Where did you hear that?

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