The Dow Jones returns to its old pattern

I am often asked if I would consider using any other method than tramlines, Elliott waves, and Fibonacci in my trading. The simple answer is: yes, if it helps me discover useful insights into market direction!

Every six months in March and September, I dust off my equinox indicator and see what it is telling me.

So, what is the equinox indicator? Has it anything to do with the arcane world of astrology?

Whether it does or not, it is a curious fact that around the time of the spring and vernal equinox, the markets often take a significant turn in direction. In nature, tides are often at their highest around these times and therefore, the heights of tides are at tops or bottoms around the equinox.

And last week, the Dow made an all-time nominal high and is therefore a candidate for a top. But that is not all. Here is the weekly chart going back several years. Admire how the various prior pivot points (PPPs) were set years before:

Dow Jones spread betting chart

Since March this year – at the time of the spring equinox – the market has re-entered the trading channel, which has been empty for over five years.

If you need to prove to a friend that markets are patterned and have a memory, just show them this chart!

Also notable from the chart is the clear weakening of momentum while trading in the channel between the tramlines. That is a warning sign that the market may be ready to make a major reversal at any time.

Dow Jones spread betting chart

After the Fed’s decision not to cut back on quantitative easing (QE) last Wednesday, the Dow exploded to the upside and created a gap.

Then the market hit the brick wall of the upper multi-year tramline on Thursday, and it was sent packing, and closed Friday just above the gap.

Gaps are very interesting when they occur – which is rarely in the almost 24-hour trading world. Most of the time, gaps tend to be filled back in quite promptly.

And note the high momentum reading, in a region where previous tops were made. Note also the weakening momentum going into the highs, giving rise to large divergences, which is one of my biggest warning signals when looking for a turn.

Are hedge funds smart traders?

With the best brains in the business on mega salaries and bonuses, you would certainly expect them to be! Some think that if you follow their actions, you will be as rich as them.

But here is the latest commitments of traders (COT) data for the mini Dow future:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
($5 x DJIA Index) Open interest: 136,227
Commitments
37,990 7,877 4,811 76,834 99,705 119,635 112,393 16,592 23,834
Changes from 09/10/13 (Change in open interest: 30,103)
13,305 -2,254 4,752 12,208 24,197 30,265 26,695 -162 3,408
Percent of open interest for each category of traders
27.9 5.8 3.5 56.4 73.2 87.8 82.5 12.2 17.5
Number of traders in each category (Total traders: 103)
30 17 17 45 27 84 55

 

This is the snapshot as of the close on Tuesday 17 September – one day before the critical Fed announcement.

You can see that the hedge funds (non-commercials) filled their boots with longs (unlike the non-reportable small traders, who turned more bearish). The big boys were betting that the Fed would announce at worst only a slight reduction in QE support. It was to be business as usual.

Note the huge lop-sided position: the hedge funds are now almost five-to-one bullish.

But please don’t take this raw data at face value – hedge funds apply some very complex hedging strategies and not all of the positions shown in COT are solely directional bets.

And after the report the market rallied on the news that the Fed would not taper bond purchases soon, which took the Dow up to the upper tramline.

But then, on Friday, a Fed member broke ranks and suggested that the Fed would indeed start reducing QE soon. And that about turn brought out the selling.

Dow Jones spread betting chart

Isn’t it remarkable that even with the extreme bullish reaction to Wednesday’s news, the market could only make it to exactly my multi-year tramline – before being slapped back down?

It was as if the market knew in advance there would be some less bullish developments a day later.

This is one more example of how trading solely on the news can be extremely hazardous to your wealth.

Hedge funds caught off-guard in Treasuries

I always keep an eye on US Treasuries, as they are the cornerstone of the Fed QE policy. In fact, the 30-year T-bond is one of my favourite trading vehicles.

But it is the ten-year Treasury note that is the main market since it drives many consumer rates.

And last week, the COT data was revealing:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of $100,000 face value) Open interest: 1,968,911
Commitments
173,420 299,446 47,240 1,494,089 1,201,201 1,714,749 1,547,887 254,162 421,024
Changes from 09/10/13 (Change in open interest: -145,403)
-19,704 20,998 -9,607 -138,655 -122,394 -167,966 -111,003 22,563 -34,400
Percent of open in terest for each category of traders
8.8 15.2 2.4 75.9 61.0 87.1 78.6 12.9 21.4
Number of traders in each category (Total traders: 300)
40 71 37 114 153 178 237

 

To back up their bullish stock bets, hedge funds also bet on Treasury yields rising (prices falling) as they expected the Fed to begin reducing their bond purchases.

That is why they swung massively to the bearish cause ahead of the report.

Here is the ten-year Treasury market’s reaction to the Fed news:

US 10-year T-bonds spread betting chart

I call that a short squeeze of around 200 pips! For the longs, that was sweet.

Sadly, the COT data is released a few days after the snapshot and cannot be used for fine-tuning trade entries.

But it does show the current balance (or imbalance) in the market. This is invaluable information for those who know how to use it.