Campaign Trading: Maximizing Profits with Interval Ladders

Potential Topping Action

The T-bond/T-note spread is getting interesting here. On the weekly timeframe, a double top could be forming between the late August high of 15-06.5 and the mid-October high of 15-08.5. Coincidentally, this potential double top is forming just a few ticks shy of the 2013 weekly high at 15-14. A break below the weekly mid-September correction low of 12-19 without scoring a new high first would confirm the double top.

T-bonds T-notes spread weekly

T-bonds T-notes spread weekly

Don’t forget that we previously discussed how an end-of-week close below the weekly 20-bar Moving Average (likely to be around 13-11 next week) for the first time since the start of the year would signal a bearish trend change. This would occur before double top is confirmed. If so, this US Treasury spread could be in for one heck of a decline.

Full Court Press

If the interest rate spreads are on the cusp of a major trend change, it’s high time that traders get a game plan together in order to maximize the opportunity. There are different ways to skin a cat, but I want to discuss a personal preference that has worked well for me.

It may first appear counter-intuitive, but I would add to the short interest rate spread position only as the price is declining. Sell more into weakness, not on strength. There’s no dollar-cost averaging when prices move adversely during this sort of trading campaign. It’s purely about momentum. We only want to press the advantage when the market proves us correct by moving in the anticipated direction.

Climbing a Ladder

One method I like to employ for adding to a position is to create a price interval ladder. A series of progressively higher (or lower if you are trading the short side) price targets are set ahead of time for the spread to get to. Each time the spread can meet the target a new position is added. At the same time, the price liquidation levels are trailed for all of the other positions accumulated up to that point. As the market continues to ‘climb the ladder’ more positions are added and the price liquidation levels for all the other positions are raised as well. That way you are increasing the position size while still keeping the risk in check. That’s theoretical, of course. Markets can sometimes blow right through your liquidation levels and leave you hung out to dry. This is why you should also consider capping the amount of ‘add-on’ signals you are willing to take.

Determining the Price Intervals

There are many ways one can determine the interval spacing for the price ladder. One simple way I like to do this is to determine what size of volatility the spread has seen up to that point and use an interval progression that is a bit larger than what we would expect from random noise in the market.

For instance, if the daily swings or counter-trend moves are $1,000 then buying in price intervals of $500 would likely result in a lot of activity and a lot of losses. This is because the spread can easily fluctuate twice that amount without ever making any progress on the trend. However, buying in price intervals of $1,500, $2,000, or even greater will have less activity but have a much higher probability of success. This is because the interval size is bigger than the typical fluctuations in the market and is more likely to be meaningful when achieved.

Updated Trade Strategy for the T-bond/T-note spread

Previously, the blog was working a hypothetical trade to sell one December T-bond contract and simultaneously buy one December T-note contract if the nearest-futures spread makes an end-of-week close below the weekly 20-bar MA (by at least one-quarter of a point). Let’s revise this and put the price interval ladder strategy to work.

After bottoming at the bear market low on November 20th the nearest-futures T-bond/T-note spread has risen just over eleven full points in eleven months. Between November 20th and the end of August, the pullbacks in this uptrend were between one and a one and a half points in size. The two and three-quarter point break from the August 28th high finally allow the spread to break rank and trigger a false trend change signal.

T-bonds T-notes spread daily

T-bonds T-notes spread daily

Tossing aside that big decline into the September low, none of the other counter-trend moves this year exceeded one and a half points. Therefore, we would employ a price ladder with intervals that are two and one-quarter points apart. This is 50% larger in size than all of this year’s other pullbacks. It should keep us outside of the random fluctuations.

Trade Parameters:

The blog will now work a hypothetical trade to sell one December T-bond/T-note spread on a close below 14-00 (premium T-bonds). If filled, the position will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the entry price. Add additional spreads (single contracts for sake of simplicity) on closes 2-08 lower than the prior entry price until a total of four units (the initial entry plus three ‘add-ons’) have been accumulated. For a trailing stop, all units will be liquidated on a two-consecutive day close 2-08 (two and one-quarter points) above the most recent entry price.

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