One concept I have been examining lately is the idea that turning points in one market (the lead market) might forecast turning points in a secondary market. In this case, I am looking at if objectively defined turning points in bonds might lead the stock market. For this study I used ETF (SPY, TLT) data. By the way, If you have not read my “Using bond market data to trade stock indexes” you might want to do so before reading this article.
The first step is to quantitatively define exactly what a “turning point” is in the lead market. In this case, the basic idea I am using is a one day decline after a relative high (X day high) is made in bonds.
Here are the numbers for one iteration of this concept:
The above strategy actually has one tweak to the signal that is not based on the prior bond (TLT ETF) behavior: Interestingly, I found that over many parameters, this idea worked best (created the highest expected return) after the stock index was up (close to close) the prior day. People who are experienced with this type of stuff might find this interesting, as usually expected return is higher after a down day. The bond signal with no reference to prior day stock behavior generated a .33% (close to close) return over the test period. Do to the larger number of trades it maintained about the same level of total profit.
There are countless ways to play with this basic idea. For example, I found that altering the magnitude of the “one day decline” element of the strategy created logically consistent results. If you have followed my blog you know that I don’t put much stock in specific rule-sets. Rather, I like conceptual ideas that work over a broad range of rules or parameters. So far, this “Turning point” idea seems to be showing promise. If you liked this article, make sure to check out my latest article on short-term S&P 500 trading (click here).
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