Stocks & Commodities V.

4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

Technical analysis of the Dow 20 Bond Index

by Howard Waxenberg

O ver the years, the correlation between moves in the bond market and moves in the stock market has
been tremendous. In the last several years, we have repeatedly seen the condition where bonds rally and
then four to six weeks later stocks start a bull move. There is a repeating pattern at tops as well where
bonds top out and, on average, two weeks later equities begin to falter. So, it makes sense then, that
predicting moves in the bond market through technical analysis has two effects. First, of course, is
predicting the future direction of bonds and interest rates, and second, through knowing the direction of
bonds we can have an outlook on equities, both the direction and the duration of an expected move.
Today there are many measures of the debt markets and many debt markets to measure. There are
government and corporate bonds and notes, Treasury bills, debt instruments from government agencies,
CDs, the money markets, and so on. There are financial futures, options on financial futures, closed end
bond funds, utility stocks and here, in the investment vehicles, the list also goes on.
There is one measure of the debt market that is readily available, easy to understand, and is fairly easy to
analyze technically. This is an index that has been around for a few years as well—the Dow 20 Bond
Index and its internal statistics. The Index and its stats are found daily in the Wall Street Journal , most
financial sections, and is summarized on weekends in Barron's. Let's take this one measure of the debt
market, apply technical analysis to it, and see what can be learned regarding predicting the direction of
interest rates, the debt market and equities.
The first step is to record the daily and weekly close of the Dow 20 Bond Index. From the daily closing
you will want to construct 20-day, 30-day, 50-day, and 200-day moving averages. (My research has
shown that moving averages shorter than the 20-day period tend to give many false signals.) These
moving averages will serve as points of support and resistance for the Index. Signals as to the direction of
the Index and the entire debt complex are given when the 50-day line crosses above (bull) or below (bear)
the 200-day line. On these crosses, it is best to see two consecutive days above or below the line to
eliminate any false signals. The strongest condition is for the Index to be above its 20-day line, and for
the 20-day to be above the 30-day which is above the 50-day which is above the 200-day. The weakest
condition is the reverse of what I have just presented.
With the Friday closing price of the Bond Index, you can construct 10-week and 50-week moving
averages. These averages will serve as intermediate- and long-term support and resistance points. The
Index shows a strong condition when it is above its 10-week and 50-week averages. A weak condition
would be for the 10-week to cross below the 50-week line and for both averages to be above the Index.
This is an intermediate-term measurement of the Index being overbought or oversold. This oscillator will
take time to develop, but it is very good for intermediate-term trends.
There are many choices for charting the Index. I recommend using two point-and-figure charts based on
daily closing of the Index. The first should be a .1 by .3 three box reversal chart (see Figure 1). The
second should be a 1 by 3 three box point-and-figure chart. These charts will give you additional
intermediate-term and long-term points of support and resistance. Also, with point-and-figure charts, you
can do price projections when the Index breaks out or down from a formation. I would then draw a bar

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Stocks & Commodities V. 4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

FIGURE 1:
Stocks & Commodities V. 4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

chart for the weekly high, low, and close from the data presented in Barron's. This weekly bar chart will
give you a very good look at the intermediate and long-term trends, although it won't help too much in
determining support and resistance points.

Trends generally have a longer time period in the bond market

than in the equity market.
Next, take the daily closing prices of the Index and construct a momentum oscillator that will tell us
when an intermediate-term move is beginning and ending. This is done by taking the price today,
subtracting the price of the Index 12 days ago, and then making a 10-day moving average of that
difference. Plot this as a line graph (see Figure 2). Next take the price of the Index today and subtract the
price of the Index 34 days ago, and make a 10-day moving average of that difference. Plot this on the
same chart as the other rate of change indicator.
What you are looking for here is a buy signal formed when the 12-day indicator turns up from a
bottoming formation, such as a double bottom (Figure 2). The "turning up" should occur from below the
zero line of the chart. This would be confirmed by the 34-day line turning up and confirmed again by the
12-day line passing through the 34-day line.
The move in the Bond Index would be over when both lines turn down from above the zero line of the
chart and this would be confirmed by the 12-day line passing below the 34-day line and then through the
zero line of the chart. A longer-term oscillator can be constructed by using the weekly closes of the Index
and working with a 12-week rate of change.
One other oscillator can be constructed that will give a signal of breakout on either the upside or the
downside. This oscillator uses the 20-day moving average of the Index which we constructed early in our
analysis (Figure 4). Take the 20-day line and draw a band around the line that is .06 percent greater and
.06 percent less than the 20-day line. When the Index closes above or below those bands, it has had a
short-term breakout or breakdown and you can expect the move to carry on for several more days.
We are fortunate in that the Dow 20 Bond Index is published with data from the New York Bond
Exchange. This internal data of advances and declines as well as highs and lows allows us to do some
further analysis on the internals of the market— the things that are behind the price structure of the
market of the Dow 20 Bond Index.
The analysis that we use here is similar to that which we have used before. We take the daily differential
of advancing and declining issues and construct a running total of the difference—an advance-decline
line. From the daily difference of advances and declines, we can also construct a 12-day rate of change
oscillator that we can match against our price oscillator constructed above to use as a confirming tool. In
addition, we can construct an unweighted advance-decline line by taking the daily difference in advances
and declines and dividing this by the total number of bonds traded. This resulting number is made into an
advance-decline line. Both a-d lines should be plotted on point-and-figure charts, using 100 by 300 for
the first line .5 by 1.5 for the second.
We are looking for chart formations in the advance-decline lines that support the price of the Dow 20
Bond Index. New highs in the Index should be supported by new highs in the a-d lines. The lines should
reflect the current intermediate trend of the Index moving up or down depending on whether we have a

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Stocks & Commodities V. 4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

FIGURE 2:

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FIGURE 4:
Stocks & Commodities V. 4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

bull or bear trend. Reversal formations on the lines on the chart should be taken as warning signs that
some change of trend may be starting to take place in the Index itself.
In regards to the highs and lows posted each day on the bond exchange, you will find that there is only a
general correlation of their action to that of the price action of the Dow 20 Bond Index. What you are
watching for here is that the highs and lows support the general trend. I feel the best measure of this is to
keep a 30-day moving average of the daily differential between highs and lows. You want this average to,
in general, move in the direction of the intermediate-term trend of the Index in order to have some
confirming technical evidence. One point here on the length of trends: they generally have a longer time
period in the bond market than in the equity market. I find most people think of an intermediate-term
trend in equities to be on the order of four to six weeks. In bonds I would say an intermediate-term trend
is in the order of two to three months.
One last indicator can be constructed from the highs and lows of the bonds by dividing the number of
highs by the number of lows and highs. Construct a 10-day moving average of the result of the division
and plot that result on a .1 by .3 three box point-and-figure chart. Again, you are looking for confirming
patterns in the indicator chart to the chart of the Index itself.

The Dow 20 Bond Index is an excellent tool for spotting

speculative excesses in the markets.
You should know that the Dow 20 Bond Index is one of the last debt market indices to start an
intermediate-term move up and one of the last to turn down. Obviously, the financial futures show the
turns first. Next come the New York Financial Index and the Dow Jones Utility Average. Generally,
these are followed by the NASDAQ Bank Index and NASDAQ Insurance Index. There is a real value to
the Dow 20 Bond Index reacting so slowly—it is an excellent tool for spotting speculative excesses in the
markets. When buyers are really reaching to lock in long-term yields, you will see the Dow 20 Bond
Index really outperform all other financial indices to the upside. When this occurs, the bonds are showing
the best strength relative to the other segments of the financial markets. Watch for the markets to turn
lower for the intermediate-term trend.
You can also use the average time between an intermediate-term bottom in the Dow 20 Bond Index and
an intermediate-term bottom in either the Dow Industrials or the New York Composite. Keep updating
the average after every intermediate-term bottom. Do the same thing for tops. This should help you
greatly in spotting future bottoms and tops in the equity markets.
The last technical tool that I work with involves the weekly figures for the Bond Index. I record high,
low, and close. Then I determine if the Index closed in the upper, lower, or middle third of its weekly
range. A closing in the upper third rates a +1, the middle third is a zero, and the lower third is a –1. A
running total is kept which is used to measure against the long-term trend of the Index. It should show
new highs with the Index, and not diverge for more than two weeks at a time. It should, of course, show
new lows in a downtrend.
The analysis that I have put forth can be easily done by hand, although a spreadsheet and a personal
computer could speed you along. The combinations of tools, no matter how they are calculated, should
give you an excellent look at the internal technical condition of this key market index that is currently
being overlooked by most technicians. This insight will give you more success in the markets.

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Stocks & Commodities V. 4:8 (321-321): Technical analysis of the Dow 20 Bond Index by Howard Waxenberg

Howard K. Waxenberg (619/481-3074) writes a daily technical letter for institutional investors.

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