T-bond/T-note Spread: Roll to the June Contracts

Waiting For the Next Shoe to Drop

The IMC blog initiated a short position in the March T-bond/T-note spread at 26-18 (premium bonds) on January 20th.  For the last month, we’ve had little to show for our efforts as the spread has remained range-bound.

However, the spread did flash a major bearish signal back in early October when it closed below the widely-watch 200-day Moving Average for the first time since the first week of 2016.  We felt that the right move was to get short once the rally off the December low started to fade.  We still think that.

t-bond-t-note-spread-50-and-200-mas-daily

T-bond T-note spread (50 and 200 MAs) daily

A breakout above the current trading range would be our signal to take a loss on this initial trade and get to the sidelines.  If that occurs, it would increase the possibility of a rally to resistance at the declining 200-day MA where we would watch for a setup to take another crack at it.  Until then, we simply stay short.

First Notice Day for the March treasury contracts is on Monday.  Therefore, we have to roll to the June contracts today in order to maintain our position.

Trade Strategy:

Liquidate the short March T-bond/T-note spread and simultaneously enter a short June T-bond/T-note spread at the market-on-close on Friday, February 24th.  Risk the June spread to a two-day close above 27-24.  

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T-bond/T-note Spread: Time to Get Short?

Dead Cat Bounce

The US treasury market spent the last half of 2017 going straight down.  An improving economy, a December rate hike with the prospect of more to come, the post-election stock market explosion, and ideas that a Trump victory will make things even better have caused traders and investors to abandon bonds as quick as possible.

For the last month, however, the treasury market has bounced back on ideas that the meltdown has been overdone.  From a technical standpoint, this looks like nothing more than a “dead cat bounce” or a correction in an overall downtrend.  If so, this is a short sale opportunity.

Yield Curve Spread

As readers know, the IMC blog is all about trading the intermarket spreads.  Treasuries are no exception.  Therefore, our interest lies in identifying trade opportunities in the T-bond/T-note spread.  Old time traders may remember this one as the NOB spread (Notes Over Bonds).

One thing you may notice on the blog is that we often trade the T-bond/T-note spread at a ratio of 1:1.  Many yield curve traders do this spread at a ratio of 3:1 where they have three ten-year note contracts for every one thirty-year bond contract.  This is done to account for the higher volatility on the longer end of the yield curve and smooth out some of the volatility.

The reason I have always done a ratio of 1:1 is to get positioned for a more directional bet.  This allows me to take a smaller spread position that I would have to do with a 3:1 ratio to match my risk appetite.  It also means I pay less in commissions.

There’s no right or wrong here.  It’s a choice to make based on your personal preference.

The Last Few Weeks

The nearest-futures T-bond/T-note spread rallied nearly three full points off the December multi-month low.  This bounce is a little bigger than the two and a quarter point bounce off the September low.

So either this is an ‘overbalancing of price’ that marks a trend change…or it’s the perfect place for the decline to quickly resume and take the T-bond/T-note spread to new lows.

I’m sure someone reading this is saying, “Gee, smart guy, that’s not much help.  You’re saying it could go either way then!”  Well, that’s just the first observation of the recent price action.  Let me put another layer of technical analysis on top of that to bring some more clarity.

Trend Parameters

Most market technicians are familiar with the 200-day Moving Average.  It’s probably one of the first things you learned about when you started charting.  The 200-day MA is a cornerstone metric used to determine the long-term market trend.

In late February of 2014, the nearest-futures T-bond/T-note spread made a sustained close above the 200-day MA for the first time in nine months.  This bullish trend change signal did its job well as it carried the spread higher for nearly two and a half years.

Who says that trend following is dead?!

Now, we do have to acknowledge that there was a brief period of choppiness in late 2015 when the spread dropped below the 200-day MA in the first part of November for a few days and recovered.  It then dipped back under the 200-day MA again for a few days at the December and recovered right after the new year began.  These were both false bearish trend change signals.  Other than that, though, the spread maintained itself above the 200-day MA.  So it still works a lot more often than not.

After topping at a record high last July, the spread pulled back, hit a trading range for several weeks, and then started to work lower again right after Labor Day.

On September 16th the T-bond/T-note spread came within spitting distance of that widely-watched 200-day MA.  Apparently, the significance was not lost on market participants because that’s where the big bounce happened that we talked about earlier.

The Game Changer

The bounce off the mid-September low faded as the third quarter drew to a close.  Then something very significant happened in the first week of October: the T-bond/T-note spread dropped to a new multi-month low and made a sustained close below the 200-day MA for the first time since the first week of 2016.

This was a major bearish trend change signal.

t-bond-t-note-spread-200-ma-daily

T-bond T-note spread (200-day MA) daily

Over the next two months, the T-bond/T-note spread dropped an additional nine full points.  That’s a big deal in Treasuries!  This spread is in a bear market, folks.

Zooming In

Take a look at how the spread has reacted to the 50-day Moving Average as well.  After peaking in early July and then hitting a trading range in August, the T-bond/T-note spread made a two-day below the 50-day MA for the first time in over three months.

In the first part of September, the 50-day MA also started to roll over.  This tipped the scales further in favor of the bears.

t-bond-t-note-spread-50-ma-daily

T-bond T-note spread (50-day MA) daily

Interestingly, the rally off the December low pushed the spread up enough to finally get a close back above the 50-day MA this week.  This is either an early warning that a bullish trend change is coming or it’s the maximum stretch point before the rubber band snaps back.

The spread is starting to sell off today.  A close under the 50-day MA today could indicate that technical resistance held and that the bounce is over.  Therefore, this provides a setup for a short sale.  We are willing to take it and see if this Friday the Thirteenth is our lucky day.

march-t-bond-t-note-spread-daily

March T-bond T-note spread daily

Here’s one more for the road: On November 3rd the 50-day MA closed below the 200-day MA for the first time in nearly nine months.  This was a classic death cross signal.  Who wants to fade that?!

t-bond-t-note-spread-50-and-200-ma-daily

T-bond T-note spread (50-day and 200-day MA) daily

Trade Strategy:

T-bond/T-note Spread

The blog will make a hypothetical trade by shorting one March T-bond contract and simultaneously buying one March T-note contract if the spread closes below the 50-day Moving Average (currently at 27-01).  Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the 2017 high (currently at 28-00).

10-Year Treasury Spread: Canada vs.US!

Close Correlation with Canucks

The correlation between the Canadian 10-year bond and US T-notes is strong.  I mean, really strong.  As a matter of fact, whenever someone gets busted trading US treasuries on inside information about a jobs report or something like that, you’d wonder why they didn’t just trade the Canadian bond instead of the T-note in order to stay off the radar.

By the way, I am not actually advocating this.  If someone does this and gets caught, don’t blame me!

Canadian bond T-note overlay weekly

Canadian bond T-note overlay weekly

There are periods where the trends in these bonds can diverge for a bit, but it doesn’t seem to last more than a few months.  So any diversion could be a setup for a mean-reversion trade.

There are also periods where one treasury will move faster than the other.  If this pushes the spread to historically extreme levels, you have another potential opportunity for a reversal trade.

Way Up North

Don’t forget that treasuries prices trade inversely to the interest rates.  So the global bull market in treasuries means we’re in a global bear market for interest rates.

The Canadian economy is weaker than the US.  Therefore, their rates are lower, which means that their corresponding treasuries are higher.

In the cash market, the yield on the US 10-year note is at 1.57% while the yield on the Canadian 10-year bond is at 1.10%.  That may not seem like a big deal, but the 42% percent premium on the US yield has pushed the Canadian 10-year bond futures contract to a full 16-point premium over the US T-note futures contract.  This is a rich premium.

At the peak in 2006, the premium on the Canadian bonds was less than half of what it is today.  When the 2006 high was surpassed two years ago, the spread between the two treasuries more than doubled over the next several months.

Canadian bond T-note spread weekly

Canadian bond T-note spread weekly

The only other time that the premium on Canadian bonds has been this fat or higher was for a few months either side of the Y2K (non-)event.  By the end of the year 2000, Canadian 10-year bonds were trading at a discount to the US T-notes.

Suffice it to say, the current premium on the Canadian bond/T-note spread is at an historically high level.  This could create a breeding ground for a major reversal.

The Wall

In February 2015, the nearest-futures Canadian bond/T-note spread cleared the 16.50 mark.  It peaked out at 16.90 less than a week later and reversed on a dime.  The spread then plunged over six points over the next two and a half months.

In August 2015, the nearest-futures Canadian bond/T-note spread once again clipped the 16.50 mark.  It peaked out just one day later and started a two-month decline.  The drop ripped nearly four and a half points off the spread.

Canadian bond T-note spread (nearest-futures) daily

Canadian bond T-note spread (nearest-futures) daily

Just a week ago, the nearest-futures Canadian bond/T-note spread closed above the 16.00 level.  This is not quite the 16.50 mark that told us to set the timer for the reversal the last two times, but it’s getting close.  Based on the daily chart for the September spread, there’s a good reason to start monitoring the situation closely.

Will the Fib Stop Cause a Flip-Flop?

The September Canadian bond/T-note spread faces technical resistance at the Fibonacci .618 retracement of the entire decline from the January 15th contract high to the April 29th multi-month low.  That Fib level is located at 15.97.

September Canadian bond T-note spread daily

September Canadian bond T-note spread daily

Last Wednesday, the September Canadian bond/T-note spread closed slightly above the Fib retracement for one day.  It then backed off and has been sitting still for the last week.  Traditionally, the Fibonacci .618 retracement is an ideal point to look for a secondary lower top to form before a market starts another leg down.  If this happens in the spread, we’ll take a crack at the short side.  If not, we will simply trail it higher with moving short sale parameters.

It’s also a point of interest that the spread closed about a third of a point below the Fibonacci .618 retracement last month and then endured a correction.  The June 2nd high set price resistance that was surpassed on July 11th.  The fact that the spread is now back below the early June top is indicative of a breakout failure, or what we like to call a Wash & Rinse sell signal.  If prices continue to erode from here, a short sale could be warranted.

Trade Strategy:

Place a hypothetical contingency order to sell one September Canadian 10-year bond contract and simultaneously buy one September T-note contract if the spread closes below 14.93 (premium Canada).  If filled, liquidate the position on a two-consecutive day close .20 points above the rally high that precedes the entry (currently at 16.05).

US Treasuries: One Out and One Down

Knocked Out

The IMC blog initiated short positions in the US yield curve at the beginning of March.  Thanks to the weaker-than-expected jobs report last week, one of the liquidation parameters were elected.

A short September T-bond/T-note spread was entered at the equivalent 31-14 on March 1st and liquidated at 35-20 on June 3rd.  This resulted in a loss of -$4,187.50 per spread.

Also, a short September T-note/5-Year note spread was entered at the equivalent 9-12.5 on March 1st.  The exit criterion is to bail on a two-consecutive day close above 10-06.  This hasn’t happened yet, but it’s gotten awfully close.  The spread hit 10-05 just last week!

Stretched Thin

Despite the fact that the T-bond/T-note spread was liquidated, it remains on our radar screen for another potential short sale.  The September spread posted a new contract high and is now just a tick away from the 36-00 mark.  This puts it right on the doorstep of the 2015 top at 36-14 and the February 2016 peak at 36-10.

T-bond T-note spread daily (nearest-futures)

T-bond T-note spread daily (nearest-futures)

However, the nearest-futures spread hit a new high of 37-12 today.  This is a bullish event for the spread.  Because of this potential breakout, we’re going to hang back a bit and see if the breakout is sustainable or not before we post any reentry parameters.  A two-day close back under the February high of 35-11 in the September spread could do the trick.  If something interesting develops, we’ll certainly have more to say.

US Treasuries: Roll to Labor Day Spreads Ahead of Memorial Day!

Roll With the Punches

On March 1st the IMC blog initiated a couple of short positions on the yield curve.  A short June T-bond/T-note spread was entered at 32-24 and a short June T-note/5-Year note spread was entered at 9-03.5.

We’ve taken some punches on these spreads since we got in them, but not enough to knock us out of the game yet.  For instance, we were risking a two-day close above 35-19 on the June T-bond/T-note spread.  The spread made a one-day close above this level on April 7th and a one-day close above this level on May 13th (a Friday the Thirteenth, no less!).  It was close, but we survived it.

Due to the First Notice Day for the June futures contracts next week, the positions needed to be rolled to the September contracts.

The Lay of the Land

Fundamentally, decent economic data and comments from several Fed members –including Janet Yellen- have substantially increased the odds of another rate hike in June or July.  This helped cap the rally in the US treasury market.

June T-bond T-note spread daily

June T-bond T-note spread daily

Technically, a double top appears to have formed on the June T-bond/T-note spread at the April 7th and May 13th highs, both located at 35-24.  To confirm this ominous pattern, the low between the two highs needs to be broken.  That low is located about two full points from here at the April 26th low of 32-01.5.

T-bond T-note spread weekly

T-bond T-note spread weekly

Resistance for the T-bond/T-note spread is apparent on the weekly time frame as well.  The 2015 peak was established at 35-26.5 and the spread topped out at 35-22 in February and 35-24 this month.

Closer in on the yield curve, the June T-note/5-Year note spread hit a wall of resistance as well.  The spread peaked near 9-30 on February 11th and then it put in some slightly lower highs of nearly 9-22 on April 7th and 9-21.5 on May 13th.

June T-note 5-year note spread daily

June T-note 5-year note spread daily

In light of this, the plan is to roll to the September spreads and risk a breakout above the April/May highs.  We’ll come back and talk about increasing the position size only if the US treasury spreads get well below their April lows.

Trade Strategy:

T-bond/T-note Spread

Liquidate the hypothetical short position in the June T-bond/T-note spread and simultaneously enter a hypothetical short position in the September T-bond/T-note spread at the market-on-close on Tuesday, May 24th.  Risk the September spread to a two-consecutive day close above 34-19.

T-note/5-Year-note Spread

Liquidate the hypothetical short position in the June T-note/5-Year note spread and simultaneously enter a hypothetical short position in the September T-note/5-Year note spread at the market-on-close on Tuesday, May 24th.  Risk the September spread to a two-consecutive day close above 10-06.

US Treasury Spreads: We’re Short For the Long Decline

The Big Bond Break?

The IMC blog initiated a couple of short positions on the yield curve yesterday. We shorted the 30-year bonds against the 10-year notes and we shorted the 10-year notes against the 5-year notes.

The short June T-bond/T-note spread was entered at 32-24. We are initially risking this spread to a two-day close above 35-19.

The short June T-note/5-Year note spread was entered at 9-03.5. We are initially risking this spread to a two-day close above 10-06.

June T-note 5-year note spread daily

June T-note 5-year note spread daily

Both spreads broke their mid-February lows, resulting in a lower correction low after a preceding bounce to a lower high. A lower high, followed by a lower low, is what we’d expect in a downtrend. Hopefully, this is the start of it.

Making It Complicated

As we pointed out at the end of the last post, a trader would not actually have both spreads on because the LONG 10-year in the first spread and the SHORT 10-year in the second spread would offset each other. This would simply leave you short the 30-year bond and long the 5-year note.

Although we are running both spreads for hypothetical purposes, a trader should focus on the one that best fits their own risk profile. The further out on the curve, the higher the volatility. So the T-bond/T-note spread is going to be more volatile than the T-note/5-Year note spread.

Now in the event that you want both spreads for diversification, you could short the T-bond and buy the 5-Year note. If one spread triggers the exit criteria but not the other, close out the contract that should have been exited (either the T-bond or the 5-Year note) and then put the T-note contract on to complete the remaining spread. Capisce?

Because We’re Optimists

Perhaps we’ve just entered the start of a big decline. If so, we’re going to want to squeeze all we can out of it. Therefore, we will need to find a spot to add to the short positions.

To recommend the ‘add-on’ positions, we’d like to see some setups where the spreads fall a bit, make a countertrend bounce that peaks either side of the initial entries, and the drops to new lows for the move.

If we’re lucky enough to see events unfold this way, we can move the initial liquidation parameters down to either side of the entry prices. This serves to eliminate most of the initial trade risk.

Another consideration is the use of price intervals where more spreads are sold in incrementally lower prices. The intervals would be based on the size of the countertrend moves as a proxy for volatility. We’ll cross that bridge if we come to it. For now, let’s just cheer for a drop in the Treasury market and pray that we get though Friday’s big unemployment report unscathed.

US Treasury Spreads: The End of the Ride

Good Place For a Top

We live in a world of low or no yield in Treasuries. Many interest rates are even in negative territory! Nonetheless, when Treasuries or Treasury spreads reach prior tops or change their currently bullish price patterns, it could be worth taking an uber-contrarian position and going short.

I can’t count the amount of times that we’ve entered a spread long before it made any fundamental sense and then went on to make a huge profit. It seems that the fundamentals played catch-up weeks after we got in. By that time, the train had left the station and a big chunk of the move was already over.

The T-bond/T-note Spread

On the daily nearest-futures chart, the T-bond/T-note spread peaked at a high of 36-14 (premium T-bonds) last year…on April Fools’ Day! The top was established just a couple of weeks after the March 2015 contracts expired.

It is important to know what took place after the March 2015 contracts expired, because the June 2015 contracts were price at a significant 15-full point premium over the March contract. This was due to a change in the contract specs. The June 2015 contract is the first futures contract that reflects the period between 2001 and 2006 when the US government did not issue any 30-year bonds. Ergo, the huge price premium. So the mid-March surge was not nearly as spectacular as it looks.

T-bond T-note spread daily (nearest-futures)

T-bond T-note spread daily (nearest-futures)

Nonetheless, after the April price peak was established, the T-bond/T-note spread dropped nearly fourteen full points by the end of June.

Fast-forward to today. The global stock market sell off and ideas that the Fed will have to stop or even reverse their tightening monetary policy has propelled Treasuries higher for the last several weeks. So a week and a half ago, the spread traded to 36-10…just one-eighth of a point away from the 2015 April Fool’s top.

The T-bond/T-note spread then made a pullback into the middle of last week, followed by a rebound that erased two-thirds of the pullback. Is this a double top in the making? Maybe. The nice thing is that the pullback and initial rebound provides a great trade setup on the short side.

A break below the February 17th pullback low would mean that the T-bond/T-note spread has made a lower low after the bounce into (hopefully) a lower high. The resulting bearish price structure could mark the beginnings of a downtrend. It’s even more damning for the spread to have it happen after nearly tagging last year’s high. Therefore, traders would have a green light to get short.

The T-note/5-Year-note Spread

Moving closer in on the yield curve, the nearest-futures T-note/5-Year note spread soared to a three and a half year high of 10-07 (premium T-notes) on February 11th. It surpassed last year’s top and traded less than a point away from the 2012 all-time high. The T-note/5-Year note spread also pulled back in a February 17th low, but the bounce that followed was more muted.

The 2015 high in the T-note/5-Year note spread was 9-18.25. After surpassing it earlier this month, the nearest-futures spread pulled back below this old high and closed one-eighth of a point below it at 9-14. The spread is now back above the 2015 high. This puts it in a fluid situation:

T-note 5-year note spread daily (nearest-futures)

T-note 5-year note spread daily (nearest-futures)

A continued recovery that sends the T-note/5-Year note spread past the current high of 10-07.25 would be very bullish. It would indicate that the initial pullback and test of support worked.

Conversely, a break below the February 17th low would confirm that a Wash & Rinse sell signal has been triggered.

The Bottom Line

The run in the US Treasury spreads were followed by a brief pullback and then a bounce from last week’s correction lows. A break below last week’s correction lows could indicate that the run is over. If so, short positions would be the way to play it.

*Trade Strategy:

T-bond/T-note Spread

The blog will make a hypothetical trade by shorting one June T-bond contract and simultaneously buying one June T-note contract if the spread closes below 33-05 (premium T-bonds). Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the contract high (currently at 35-11).

T-note/5-Year-note Spread

The blog will make a hypothetical trade by shorting one June T-note contract and simultaneously buying one June 5-year note contract if the spread closes below 9-06 (premium T-notes). Initially, the spread will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the contract high (currently at 9-30).

*Being in both spreads would be the equivalent of being short one 30-year bond and long one 5-year note. The long 10-year and the short 10-year cancel each other out.  I am leaving the trade strategy as is for hypothetical purposes.  But in ‘real life’ trading, you would want to pick one spread or the other to trade, not both at the same time.

T-bond/T-note Spread: The Recent Position Was Stopped Out. Let’s Liquidate the Rest.

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds). The initial position was entered in the March spread on February 6th.

An ‘add-on’ was entered on February 20th. This second position in the June T-bond/T-note spread is currently short from the equivalent of approximately 32-30 (premium T-bonds).

Another ‘add-on’ was entered on May 20th when the June T-bond/T-note spread closed at 25-14.5. This third position was exited at today’s close of 28-21.5 for a loss of approximately -$3,218.75 per spread.

June T-bond T-note spread daily

June T-bond T-note spread daily

The June T-bond/T-note spread plunged eleven full points from the late January record high in just over five weeks. After a nearly one-month rally into the April Fool’s Day secondary top, the spread once again plunged nearly eleven full points over the following seven weeks. Based on this symmetrical pattern, it may be due for another bear market rally.

If the spread makes another bear market rally that is similar in size and duration to the March/April bear market rally, it could run until mid-June and peak somewhere near 32-16. Coincidentally, this is just past the Fibonacci .618 retracement of the decline from the April peak. Therefore, we advocate booking the current profits and looking for a new setup to reenter the short side of the spread if it trades north of 32-00 again.

Trade Strategy:

On the short June T-bond/T-note spread entered at the equivalent of approximately 35-08 (premium T-bonds) and the ‘add-on’ spread entered at the equivalent of approximately 32-30, liquidate the spreads at 28-22 or better in the after-hours market.

T-bond/T-note Spread: An ‘Add-On’ Trade Was Triggered

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds).

The blog initiated an ‘add-on’ position on February 20th at the equivalent of approximately 32-30 (premium T-bonds).

The blog initiated a second ‘add-on’ position yesterday on May 20th at approximately 25-14.5 (premium T-bonds) when the June T-bond/T-note spread closed below the May 13th correction low. This new ‘add-on’ position will be liquidated on a two-consecutive day close above 27-24, which is just above the May 15th reaction high.

June T-bond T-note spread daily

June T-bond T-note spread daily

During this nearly four-month decline, the June T-bond/T-note spread has dropped about 35 full points from the record high. As the trend progressed favorably, ‘add-on’ setups gave traders opportunity to increase the position size. Adding to winning positions is the way to take full advantage of a trending market. With no price support seen until the spread drops another eleven full points from here, hopefully even more setups will come along.

T-bond/T-note Spread: Another ‘Add-On’ Setup Has Materialized

T-bond/T-note Spread

The blog is currently holding a short position in the June T-bond/T-note spread from the equivalent of approximately 35-08 (premium T-bonds). The initial position was entered in the March spread on February 6th.

An ‘add-on’ was entered on February 20th. This second position in the June T-bond/T-note spread is currently short from the equivalent of approximately 32-30 (premium T-bonds).

On Thursday the spread closed at a new multi-month low of 25-18.5. At that point, the six-week decline of nearly eleven full points from the April Fool’s Day high was similar in size and duration to the five-week decline of the eleven full points from the January 28th all-time high to the early March correction low. Therefore, the two-day bounce that followed was not a surprise. It could have even been the start of a new bear market rally.

June T-bond T-note spread daily

June T-bond T-note spread daily

Since peaking at a secondary (lower) high on April Fool’s Day, bounces in the June T-bond/T-note spread have been one to three-day affairs. Therefore, a break to new lows after the recent two-day bounce could indicate that the bearish pattern is still intact and that the symmetry of price and time will be broken. This could keep the spread on course for a return to the mid-October low of 14-07.5.

The short-term bounces offer a low-risk entry for short sellers to enter on a break to new corrective lows and risk just above the preceding bounce high. The low risk on the trade, combined with a sizable downside target, creates a lucrative reward-to-risk scenario. Traders who are already short could use this setup as an opportunity to increase the position size again.

Trade Strategy:

The blog will make a hypothetical ‘add-on’ trade by selling one June T-bond contract and simultaneously buying one June T-note contract on a close below the May 13th low of 25-18.5. Initially, this ‘add-on’ position will be liquidated on a two-consecutive day close 8/32nds (one-quarter of a point) above the highest closing price between the May 13th low and the entry day.