The Treasury market – a lesson in tramline trading

A couple of days ago, I wrote a piece on long-term bonds, specifically the US 30-year Treasuries (T-bonds). This is a critical bellwether market for the US economy that in terms of size and trading volumes, dwarfs the stock markets.

I encourage every trader to follow this market, even if you do not wish to trade it. But be warned – the usual market received wisdom is that when stocks go up, bonds go down, and vice versa. In some periods, such as now, this is true. Thanks to recent Fed policy, risk assets have been snapped up, while lower-risk investments such as Treasuries, have been shunned. So, bond yields are moving in tandem with stocks and I expect that situation to continue.

But in others, the reverse is true. Like everything, it all depends on context.

Just scan a long-term chart of T-bond yields against the Dow and you will see what I mean.

A detailed look at a closed trade in T-bonds

I promised to follow up on this market as it was entering a very decisive phase for the simple reason that just about everyone was bearish on Treasuries – often, vehemently so. And last week I put together a T-bond trade – since closed – which I’ll talk you through over the next couple of emails.

Near the start of the week (this was before all the excitement over the credit rating agency S&P putting the US’s debt outlook on “negative”), much publicity had been given to statements from high-profile figures – such as US bond fund manager Bill Gross – announcing that they are heavily shorting T-Bonds.

Now this in itself is remarkable. Seldom do we read that major investors are taking a clear investment stance. They usually are quoted in more general terms. I smelt a rat.

As a generally contrarian individual, I am always on the lookout for trades that run counter to prevailing opinion. Don’t get me wrong – the fundamental rationale for being bearish on bonds makes a lot of sense. But, as the legendary trader Joe Granville once said: “If something seems obvious to most people, it is obviously wrong”.

I was hoping that this bond trade would bear out Joe’s maxim. If a big rally ensued, that would vindicate betting against the big boys – a very satisfying result, and the mark of a true professional trader.

Going long on US government bonds

In my last post, I’d said that if the market could poke above resistance at the 118.50 area, that could mean that the lows were in, and I could go long. And the market did indeed take out resistance at the 118.50 area. So if my thinking was correct, that level (118.50) should have now formed support for any move back down.

US 30-year Treasuries - spread betting chart

(Click on the chart for a larger version)

Wednesday 13 April, 6:00am: The market has rallied to 119.50 area, which is where a big resistance zone lies, as marked on the left of the chart:

US 30-year Treasuries - spread betting chart

(Click on the chart for a larger version)

So, the market has overcome one resistance zone, but has a lot of work to do to overcome the next one. But note my third (upper) tramline, which I have drawn equidistant from my original pair. The market has poked above it and is now drifting down, following this line.

To my eye, the market is gathering strength for another push upwards. I’ll see how things pan out. I will leave my protective stop alone for now and look to raise it to break-even if the market can break clear of my third tramline.

8:00am: Overnight, the market is holding its gains well and is trying to eat into that big overhead resistance. I am feeling a little more confident about my trade, especially since momentum on the hourly chart is correcting the overbought readings from last night.

With commodities now dropping back, that should support bonds, but any big commodity rally here should put a crimp on my bond bullish case. Let’s see what the market gives us today.

8:30pm: Rally intact:

US 30-year Treasuries - spread betting chart

(Click on the chart for a larger version)

In fact, the rally has carried to my fourth tramline at the 119.80 area.

I drew this fourth tramline while the market was still trading around the 119 area earlier today. That is the power of tramlines.

At this point, I moved my protective stop to break-even.

Friday 15 April, 9:00am: Here was the picture on Friday morning.

US T-bonds spread-betting chart

(Click on the chart for a larger version)

Against all prevailing opinion, the bonds had moved up, eating away at the substantial overhead resistance.

Dare I hope that the 121 level can be reached sooner, rather than later? Well, the minor trend was definitely up, so why not?

How the market behaved – look out for scalded cats

Let’s have a closer look at how the market behaved at my tramlines. Here is a close-up hourly chart:

US T-bonds spread-betting chart

(Click on the chart for a larger version)

Note how every time the market poked above a tramline, it drifted along it, and then, in a scalded cat bounce, moved sharply higher (red arrows mark the points of take-off).

So far, so good.

I expected stocks to be more volatile later in the day, as it was stock index options expiry, which is usually accompanied by much book-squaring.

To cut to the chase, this meant looking out for volatility in bonds too.

Friday 2:00pm: Well, the bonds did it again – this was the third time they had poked well above my (fifth) tramline. This was getting monotonous.

US T-bonds spread-betting chart

(Click on the chart for a larger version)

Here, I was only 50 pips away from my crucial 121 target.

It just shows the power of using tramlines to detect break-outs from oversold (or overbought) trends, as I did near the bottom at 118.50 only a few days ago.

I now raised my protect-profit stop to 119.30, just under the last important low.

The worst case scenario was that I would take a minimum 80 pips from this trade. But markets often disappoint, so I decided to play safe.

I will follow up on the close of this trade in my next post.

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