Wednesday, August 15, 2012

Post Mortem - What the heck happened yesterday in the bond market?

Ok, time to be an adult and dissect what happened yesterday. 

To begin with, volumes have been lower than normal for the past 2 weeks.  Anecdotaly, this is due to the August summer vacation season.  In trading terms, this translates into some percentage of market participants not active in the markets, and exaggerated moves from larger than normal volume trading.

After the 8:30 Retail Sales data, there was heavier than normal selling on the number (normal immediate post-number volume is 20-30k 10yr contracts...yesterday saw 60k contracts).  Combine this volume with the extra large corporate issuance calendar (as noted here on Zerohedge), and the selling volume in the treasury market yesterday was insurmountable given the missing market participants.  However, it was visible and displayed below.

In market profile terms, yesterday was a "b down"

And graphically....

In Market Profile and Bell Curve trading, a "b down" is the first requirement to creating an over-supply condition.  In an over-supply condition (the exact opposite of an under-supply condition), a small handful of market participants sell enough product (in this case, US Treasuries) to create such an imbalance in the market as to create a new trend.  Normally, this large selling comes from a group of large levered players in the futures market (think firms like Renaissance Tech and other Global Macro Hedge Funds).  All the mid-to-small market participants who were on the receiving end of this selling ultimately need to sell the paper that they have been given, and this is what creates a "supply distribution."  As this imbalance of unsuspecting "buyers" liquidate their holdings, this causes a cascading selling effect, bringing additional liquidators into the market.  Ultimately, when the last weak handed holder of paper liquidates, the market returns to a state of "balance" at whatever price the market happens to settle.  The transition to this balanced trading pattern will look like a classic normal bell curve (often referred to as a "D").  Normally, this balance returns to the market as the large levered sellers stand in the face of the market and buy back the paper they sold, thus alleviating the over supply condition.  These supply imbalances normally take 24-48 hours to work out, but there is no hard and fast rule. 

How does this knowledge help us as traders?  Obviously, we can't know before hand when the large initiating buying or selling will take place.  However, we can wait for it to occur and observe it when it happens.  After we recognize a large volume buyer or seller (think 100k 10yr contracts in a concentrated period of time), we can play for the supply distribution.  How do we "play for" the supply distribution?  Well, the first day of initiating selling will look like a "b down" as indicated in the chart above.  After we recognize a "b down," our next action as prop traders should be to measure the bulb of the "b" and get short somewhere between the top and the center of the bulb.  Ideally, we would sell the top of the bulb of the "b," but more often than not, if this is a true over supply condition, by the time we have recognized the "b" we won't get the chance to sell the top.  This is why we should make some sale at the center of the bulb of the "b", and make additional sales at the top of the head of the "b" if given the opportunity.

So what was my mistake yesterday?  As the day wore on, I saw the "b" forming.  I knew that there was a possibility for an over supply condition to form, which means I needed to find a way to reverse my position and get short.  Since I got caught long during this process, I was like a deer in headlights.  I "tried" to sell out my position as the day wore on by continually offering just above the market, but I was unwilling to hit a bid...I thought there might be a slight possibility for the market to drift higher, thus providing me an out.  This is the wrong way to approach the market, and is entirely due to bad psychology  During the Tokyo session, when ZN hovered around 133-05 (the head of yesterdays "b") I knew that this was the head of the "b", and that I should just reverse my position...take the loss, and make it back by being short for the upcoming supply distribution.  This is what I should have done.  Instead, I placed offers 2 ticks above this level (133-07).  My thinking was, "hey its only 2 ticks..there should be enough volatility around the head of the "b" to get me lifted."  In retrospect, it is clear that this is a horrible trading strategy.  In essence, I was "HOPING" for the market to trade up 2 ticks..rather than "thinking it would".  "Hope" is a horrible trading strategy.  I waited and waited for this to take place, until the London open (2AM in NY).  At the London open, Bund futures opened lower as these London based participants had their first opportunity to sell paper (recall that Bund Futures do not trade during the Tokyo session).  As soon as this happened, I knew that the supply distribution was in progress and I hit the first bid i could (98-28 in 10Y notes...about the equivalent of 132-31 in ZN).  Because I was stopping myself out, I just got flat, rather than reversing my position and getting short.  Bad psychology everywhere.

While there are positive strategies embedded in this post-mortem, this is first a lesson in what NOT to do.  I should have gotten flat before the Retail Sales data (i was small long...1 out of 6 units).  Everything after that was based on the fact that I already had a long position, and so i tried to reduce my average cost by buying more at lower prices.  I tried to convince myself that the NSA Retail Sales data would ultimately prove the 8:30 sellers wrong.  However, this approaches day trading from an entirely wrong viewpoint.  As soon as the large sellers appeared to be getting a "b down," (observable 3 hours after the initial selling event) I should have sold every pop and gotten short.  Anything other than that was wrong.  As a day trader, thinking about what the next months revisions will probably be, or what the effect of the Seasonal Adjustment was, are irrelevant.  The only thing that matters in day-trading is measuring buyers and sellers in the auction process, and determining if the market is tethered to a center of value, or if the market has transitioned into a short term trend.  Everything else is noise, and as a prop trader, it is our job to sort thru and ignore the noise.

So, I'm going to lick my wounds, take a breather, and just sit back and watch for the next 24-48 hours so that I can come back with a fresh mind.

I hope that my experience will aid other traders in their journey..but more importantly, I hope that I learn my own lesson.  Yesterday did not have to be a could have turned around into a profitable trading day.

more later...govttrader out


  1. i may be wrong about this, but it seems like this market (30 years) is much trendier than range-bound. how do you incorporate longer term market profile into your analysis? for example, the big logjam back in mid-June. I understand you're daytrading, so how far back do you look for insight as to where the market has been and therefore where it might like to go?

  2. As this week clearly demonstrates, relying on longer term trends to daytrade is illadvised. It should not take more than 5 days of interpreting the market thru market profile to determine where the market has been, and where it is headed on the short term day trader basis...which is where i cut my teeth.

  3. those bullshit 1 am-2am moves when london opened would boil my blood ha. it doesnt happen much but when it did, fucking market would just not look back and then the rest of the night spend on salvaging


  4. I was just reading over what i wrote for monday night / tuesday morning...and i can't believe that i missed it. I said that the mode had shifted down to 133-19..and the bottom of the bell curve ( low) was 133-12. The low print that night was 133-14 @ 4:25 AM...after which 133-20 reigned in the market between 6-7am. I must have been sleeping because i missed that move. If I had caught it (after i freakin predictd it) both Tuesday and today would have been completely different for me. I was just cursing myself out for not doing what i said i would do. Hopefully, this will be the last time i need to teach myself this lesson.

  5. Just discovered you're blog recently... interesting to follow your thoughts as treasuries are a market with which I have less experience. I'm more of a swing trader, but the reality is with any leveraged product you have to have a bit of day trader perspective on the entries / exits.

    Blogging is interesting way to keep a trading journal... putting it out there for the world to see certainly helps keep one a little more honest with oneself, else you'll get excoriated by all sorts of characters lurking on the web.

    Thanks for your thoughts... Cole