For traders with a directional bias, today was quite a FOMC day. We had mostly a slow day leading up to the Fed announcement as one might expect, followed up by a melt up of stocks after the announcement. But, unlike other FOMC days where the market really took off, the market seemed to kind of hit a wall at the “Lehman gap.”
The truth is that traders really only need to watch the US Dollar right now. The dollar was weak and the market was up. The dollar then reversed to close at its low and the market followed. Today was a nice reversal day for the bears; however, until I see my indicators break trend (US Dollar, LQD & TED spread), I am not interested in shorting the market generally.
I am away tomorrow so I did cover all of my “momentum shorts” which I discussed earlier this week. Here are the results from this week:
PSDV – Entry: $5.86, Exit: $4.88 (17% profit)
MPG – Entry: $2.64, Exit: $2.34 (11% profit)
FFBC – Entry: $12.40, Exit: $12.00 (3% profit)
If I was around tomorrow, I would have lowered my stops and let MPG and FFBC run rather than covering at the close today. I am satisfied with my profit on PSDV.
Because I am on vacation there is a certain opportunity lost for me personally if I’m thinking about my stock positions rather than enjoying my vacation. Therefore, I closed out MPG and FFBC early. FFBC is extremely attractive to hold onto because the highs for the last two days are the same meaning this can be used as a stop out to manage risk (so I will likely be kicking myself when it sells off big tomorrow).
Finally, I’ve received a few emails from readers regarding the US Dollar, LQD and the TED spread. I figured I would share my thoughts with the group. The questions were generally as follows:
1. When following the US Dollar does it matter what instrument you are using? For example, you can trade UUP (2x long dollar) and UDN (2x short dollar). So long as your currency vehicle is basket of currencies valued against the Dollar and it shows the downward trend of the Dollar since March I don’t think it matters what instrument is used. I’m using UDN because it clearly shows the dollar bouncing off the trendline since March. I would also rather go long UDN than short UUP so it is easier for me to follow the instrument I am actually trading.
2. Another question was whether 30 year treasury bond futures can be used in lieu of LQD? That will not work. LQD is an index of high grade corporate bonds. So we have apples and oranges here.
3. What resources are there to follow the TED spread (acronym for Treasury – Eurodollar spread)? I have not found it as a feature in Prophet and I therefore use Stockcharts to check it. The chart can also be pulled up on bloomberg.com. I don’t think it is necessary to check the TED spread intraday. If there is a big spike, the market will likely be down quite a bit and you will know it. It would be nice if Prophet added this as a real time ticker.
4. Finally, I was asked about whether I knew of any resources to study up on the TED spread. I am not personally an expert on the TED spread or the credit markets (disclosure). Any basic book on credit markets and bonds should provide basic information about LIBOR contracts (most popular are the 30 and 90 day contracts), treasury bills and bonds. But, for trading purposes, I don’t think you need to become an expert. The point of monitoring the TED spread is that most lending is tied to LIBOR. Therefore, if there is a spike in LIBOR, the default risk on commercial loans goes through the roof because the interest payments will be tied to the new LIBOR rate when these short term LIBOR contracts come due. For example, if a company has a line of credit it likely can only take out 30, 90, or perhaps 180 day LIBOR contracts. These are all short term. So when these contracts expire and the company wants to roll into a new LIBOR contract, the interest rate will be much higher if LIBOR spikes. I prefer following the TED spread rather than just following LIBOR because a large spread (let’s say greater than 50 basis points and certainly more than 75 bps) between 3 month LIBOR and 3 month T-Bills indicates a sick credit market whereas an increase in LIBOR may just mean an uptick in interest rates (which eventually will happen and could actually be healthy).