I had a nice trade this week in the Aussie 200, trading contracts for difference. I’ll show you how I made the decisions to enter the trade, but first of all a quick lesson in intra market relationships.
The US Treasury bond is seen as one of the safest places in the world to invest money. It is backed by the US government and despite the recent downgrade in its credit rating, the US has never defaulted on a payment. The market perceives that it is so safe that in the financial crisis of 2008 bonds were pushed up to a level that meant interest rates went negative. This means the US government was being paid to borrow by the investors!
A bond pays interest and the price of the bond changes as the market’s expectations of interest rates rise and fall. If interest rates rise, bonds fall in value and if interest rates fall then bonds rise in value. The higher the price is, the lower the return on the bond.
When investors perceive that the market environment is risky, money flows into bonds. When people are scared by stock market falls, they will buy US Treasury bonds and when people are prepared to take on more risk, they will sell bonds and buy shares. So the normal relationship between Treasury bonds and the stock market is:
• bonds up, stock market down
• bonds down, stock market up
Adding in another independent variable we can follow the relationship between the Aussie dollar and the stock market. If money is flowing into the Aussie dollar then some of it will find its way into the Aussie stock market, and if money is moving out of the Aussie dollar then the Aussie market is likely to fall. The Australian market and dollar are perceived to be more risky than the US markets so when investors are scared they sell Aussie dollars and Aussie shares and when they are prepared to take on risk they become buyers. The normal relationship between the Aussie dollar and stock market is:
• AUD up, stock market up
• AUD down, stock market down
Now back to the trade from Wednesday morning. I was watching the last hour of trading in the US markets and the setup highlighted in the charts below unfolded. The charts are hourly charts of Aussie dollar (AUD=), Treasury Bonds Dec Expiry (ZBZ1) and the S&P/ASX 200 (.AXJO). The highlighted setup occurred. The Treasury bonds fell sharply, and at the same time the Aussie dollar and Aussie 200 both fell away as well. This is not normal behaviour; remember if bonds are falling then Aussie 200 should be going up. The sharp fall in the bond market had me believe that a turnaround in the Aussie 200 was likely.
I watched the market closely for signs that the Aussie 200 had stopped falling and made my first entry around 4325 as it began to climb higher. Instead of rocketing to the upside as I would have liked, the market broke to a new low. It was still above my stop loss, but I was losing a small amount at this stage. The bonds were still lower and the AUD now turned up, this gave me the conviction to add to the trade near 4315 once the Aussie market began to climb again. The trade was supported by simple technical analysis with the market bouncing off an up trend line.
My first exit came about very quickly as the market climbed to the down trend line. There was no guarantee that a breakout would occur so I chose to take some profits early, with a gain of about 15 points on the second entry. The remainder of the position was exited just below 4350 with a limit order set to take me out when my objective had been reached. This was a gain of about 25 points on the second entry and happened to coincide with the market rolling over and falling away from this level. This was more likely good luck than good management.
By combing the view of different markets and understanding the intra market relationships I was able to make a nice profit on this trade.
By Jeff Cartridge
Education Manager
Charts from Market Analyser: download a free Market Analyser trial and test this trade setup for yourself.
