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T-Bond String Of Down Days Creates Oversold Condition
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When Fed Chairman Ben Bernanke announced QE3 on Sep. 13, 2012, he surprised a lot of bond market participants by specifying that the Fed would be buying up mortgage instruments instead of the Treasury debt that the Fed had been buying in QE1 and QE2. Traders who had tried to front-run an expected announcement of more Treasury purchases were disappointed, and their exit from that market has contributed further to what was already a fairly big washout selloff, and it has brought about an oversold condition for T-Bond prices.
This week's chart depicts that oversold condition with a simple indicator that measures the percentage of up closes for T-Bond prices over the preceding 9 trading days, and then smoothes that data with a 3-day simple moving average. As of Sep. 14, T-Bond futures prices have seen a string of 9 straight down days, which takes the raw number of up closes down to zero, but the 3-day smoothing means that this indicator has a slight lag.
Readings below 30 or above 70 in this indicator help to show when bond prices are in an extended condition. That does not mean, however, that prices cannot get even more extended, but it does show us that the rubber band is officially stretched.
The choice of the 9-day period for this indicator is an important one. Any indicator that involves a lookback period like this will work better or worse depending on how well it is "tuned" to an inherent cycle in the movements of price data. Other periods can work also, and I have found good success with 14 and 20 trading day periods. Interestingly, those longer versions of this indicator are not yet down to an oversold condition, which may suggest that there is still more corrective work to do.
This next chart looks at the 20-day total of up closes, with no 3-day smoothing like in the first chart. It is just now down to a reading of 10. When this indicator gets down to below 7, it marks what is usually a really great bottom for bond prices. The only problem is that such readings are really rare; we have only seen 5 instances of this indicator going below 7 during the past four years. So while they are nice to see when they do appear, it is hardly something that one can build a robust trading strategy around.
The reason that "counting" indicators like these can work is that they detect when a trend may have gone too far. It takes a lot of energy from the bulls or the bears to bring about a sustained trending move, and to keep the closing price changes in the up or down category. So when we see indicators like these get to an extended condition, it says that a lot of energy has been expended. That means that the forces behind that trend may be getting low on energy, and thus may not be able to continue that trend, at least not without taking time to refuel.
Those who wish to construct indicators like this for themselves can do so easily in a spreadsheet program. Just use the "IF Function" to evaluate whether today's price is higher than yesterday's. If yes, score a value of 1, if not then 0. Then tabulate across whatever lookback period you may wish to employ. I personally add a step to score unchanged days as 0.5, but those are pretty rare so you may find it is not worth the extra trouble.
The message of these two charts for the current moment is that T-Bond prices have gotten extended to the downside in the short term, and thus expecting a further continuation downward may not be justified. But the run that the bears have put together is not yet to an obvious longer term bottom indication.
Editor, The McClellan Market Report
Aug 31, 2012
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Full-On Panic Into T-Bonds