Here we will describe a trading strategy that uses a different from most systems that are based solely on technical indicators approach. This strategy is based on the use of the relationship between different markets (it is an intermarket strategy), in this case the correlation between bond futures US Treasury and futures stock index S & P 500. The only indicators are used are a simple moving average of 26 periods ( SMA 26) and a simple moving average of 16 periods ( SMA 16 ) to determine market direction in daily charts (D1) .
A relationship between markets is widely known that between the S & P 500 and the benchmark 10 - year US Treasury. The bond prices generally positively correlated with the S & P 500 (while yields are negatively correlated), although this is not always true, bonds generally precede actions inflection points. Another important fact is that one of the best operations that can be performed in the S & P 500 is when the bonus 10 - year Treasury diverges with respect to theS & P 500, so we can find the following opportunities:
- If the bonds are rising and the S & P 500 is falling, then the trader should buy the S & P 500.
- If the bonds are falling and the S & P 500 is up, then the trader should sell the S & P 500.
Although this relationship has broken down in recent years, its long-term existence is of historical importance for the science of intermarket analysis.
Therefore, the basic premise of this strategy is that a strong market bonds and market S & P 500 weak creates a bullish scenario for stocks, while a weak market for bonds and a strong market for the S & P 500 creates a bearish scenario for equities. Thus, when bonds close above the SMA 26 and the S & P 500 closes below its SMA 16, open purchase positions in the S & P 500 in the following market opening. Conversely, when the close bond below its SMA 26 and the S & P 500 closes above the SMA 16, open short positions in the S & P 500 in the following market opening.
Therefore, this strategy is based on leveraging the differences between the two markets.
Relationship between the price of the S & P 500 and bond yields of US Treasury 10-year
System configuration
- Recommended markets: The system was specifically designed to work with future (future or CFD) S & P 500.
- Recommended time intervals: This trading system was developed to operate only within the framework of daily time (D1).
- Trading Hours: It is recommended to use this system to operate during the sessions of the markets in New York and London.
- As for the indicators, this system uses only the following:
- 1 SMA of 26 periods (SMA 26) in the graph Treasuries US.
- 1 SMA 16 periods (SMA 16) in the graph of the S & P 500.
System rules
System rules are relatively simple and since this strategy was designed for daily charts, requires little supervision by the trader who does not need to spend all day looking graphics.
Signals buy / sell system
- If Treasuries are above the SMA 26 and the S & P 500 is below its SMA 16, open purchase positions in the S & P 500 in the opening of the next daily candela.
- If Treasuries are below the SMA 26 and the S & P 500 is above its SMA 16, open shortpositions in the S & P 500 in the opening of the next daily candela.
Outputs of purchase / sale
Regarding the stop loss and the level of profit taking , the system does not have specific rules for these variables and therefore the trader must set their own levels to protect against losses and to close operations with profits, according to their risk profile. This is due in part is a trading system based on key indicators, specifically the correlation between the S & P 500 and US Treasuries, and therefore is a bit vague. In this regard, it may be advisable that the trader use technical indicators to refine entries, if you prefer more precise trading conditions.
In any case, the following recommendations are made:
- Purchase transactions : If there are positions open purchase and sale system produces signals, it is recommended to close positions immediately and open sales operations.
- Sales operations: If there are positions open sales and purchase system produces signals, it is recommended to close the open positions immediately and purchase transactions.
Among the tools that you can use the trader to protect their capital we are:
- Using a fixed stop protection.
- Move the protective stop to breakeven once the price a certain amount of ticks move in favor of the transaction.
- A trailing stop that follows the price.
- A stop loss based on market volatility (based on the ATR indicator ).
- A fixed-making level benefits based on a stand or major resistance.
Example System
Example purchase transaction
Note: Sorry for the example I gave unclear. It's the only one I could find where this strategy was applied in a real operation.
In the picture above we have two daily charts (D1), one of the S & P 500 and other market Treasuries US. In the bond market chart, we can see that the price is in an uptrend, which means that we must wait for the S & P 500 has a downward movement in order to take advantage of the divergence between the two markets. In fact, in this example, the graph of the S & P 500 has a strong downward movement, which means that during this time the condition of a divergence between these two markets, usually but are always correlated positively fulfilled. Therefore, a trader may have opened a buy position at the opening of the following daily candela, after detecting the divergence, as shown in the graph.
It is important to understand that such correlations between markets are not met 100%, which signficia there are periods, especially in the short term, this strategy will not work. Therefore, the trader should always use stop loss orders to limit losses in failed operations and preserve capital account.
final recommendations
The strategy described in this article is based on an inverse correlation between the S & P 500 and Treasuries US that has remained over time, although not perfect. There are periods where the correlation is not met and therefore must be careful.
At the moment I have not tried this strategy because I do not usually operate with indexes like the S & P 500 Nor do I usually use advanced methodologies and is based on market correlations.Therefore, despite the simplicity of the rules, I recommend caution when using the strategy.
Later I will add a more complete article on how to operate the various correlations found in the markets.