In the examples used here, the bond portfolio consisted of government bonds. Of course, corporate and municipal bonds are widely held in bond portfolios. Unfortunately, there is no corporate bond futures contract. A municipal bond futures contract exists in the United States, based on an index of municipal bonds, but its volume is relatively light and the contract may not be sufficiently liquid for a large-size transaction. Government bond futures contracts tend to be relatively liquid. In fact, in the United States, different contracts exist for government securities of different maturity ranges, and most of these contracts are relatively liquid.
If one uses a government bond futures to manage the risk of a corporate or municipal bond portfolio, there are some additional risks to deal with. For instance, the relationship between the yield change that drives the futures contract and the yield change that drives the bond portfolio is not as reliable. The yield on a corporate or municipal bond is driven not only by interest rates but also by the perceived default risk of the bond. We might believe that the yield beta is 1.20, meaning that the yield on a corporate bond portfolio is about 20 percent more volatile than the implied yield that drives the futures contract. But this relationship is usually estimated from a regression of corporate bond yield changes on government bond yield changes. This relationship is less stable than if we were running a regression of government bond yield changes on yield changes of a different government bond, the one underlying the futures.
In addition, corporate and municipal bonds often have call features that can greatly distort the relationship between duration and yield change and also make the measurement of duration more complicated. For example, when a bond’s yield decreases, its price should increase. The duration is meant to show approximately how much the bond’s price should increase. But when the bond is callable and the yield enters into the region in which a call becomes more likely, its price will increase by far less than predicted by the duration. Moreover, the call feature complicates the measurement of duration itself. Duration is no longer a weighted-average maturity of the bond.
Finally, we should note that corporate and municipal bonds are subject to default risk that is not present in government bonds. As the risk of default changes, the yield spread on the defaultable bond relative to the default-free government bond increases. This effect further destabilizes the relationship between the bond portfolio value and the futures price so that duration-based formulas for the number of futures contracts tend to be unreliable.
It is tempting to think that if one wants to increase (decrease) duration and buys (sells) futures contracts, that at least the transaction was the right type even if the number of futures contracts is not exactly correct. The problem, however, is that changes in the bond portfolio value that are driven by changes in default risk or the effects of call provisions will not be matched by movements in the futures contract. The outcome will not always be what is expected.
Another problem associated with the modified duration approach to measuring and managing bond portfolio risk is that the relationship between duration and yield change used here is an instantaneous one. It captures approximately how a bond price changes in response to an immediate and very small yield change. As soon as the yield changes or an instant of time passes, the duration changes. Then the number of futures contracts required would change. Most bond portfolio managers do not perform these kinds of frequent adjustments, however, and simply accept that the transaction will not work precisely as planned.
We should also consider the alternative that the fund could adjust the duration by making transactions in the bonds themselves. It could sell relatively low-duration bonds and buy relatively high-duration bonds to raise the duration to the desired level. There is still no guarantee, however, that the actual duration will be exactly as desired. Likewise, to reduce the duration to zero, the fund could sell out the entire bond portfolio and place the proceeds in cash securities that have low duration. Reducing the duration to essentially zero would be easier to do than increasing it, because it would not be hard to buy bonds with essentially zero duration. Liquidating the entire portfolio, however, would be quite a drastic thing to do, especially given that the fund would likely remain in that position for only a temporary period.
Raising the duration by purchasing higher-duration bonds would be a great deal of effort to expend if the position is being altered only temporarily. Moreover, the transaction costs of buying and selling actual securities are much greater than those of buying and selling futures.
Get wise with payday loans
SOME VARIATIONS AND PROBLEMS IN MANAGING BOND PORTFOLIO RISK
March 29, 2010 // Posted in BOND PORTFOLIO RISK (Tags: BOND PORTFOLIO RISK) | Comments Off
Tick Volume
December 6, 2009 // Posted in Uncategorized (Tags: business, dividends, price change, taxes) | Comments Off
The popularity of quote machines and fast trading requires a measurement of volume that can be used immediately to make decisions. Because total volume is not available on a timely basis to day traders, tick volume has become a substitute. Tick volume is the number of changes in price, regardless of volume, that occur during any time interval. Tick volume relates directly to actual volume because, as markets become more active. prices change back and forth more often. If only two trades occur in a 5-minute period, then the market is not liquid, regardless of the size of the orders that changed hands. From an analytic view, tick volume gives a reasonable approximation of true volume and can be used as a substitute. From a practical view, it is the only choice.
CONTRACT VOLUME VERSUS TOTAL VOLUME
December 5, 2009 // Posted in loans (Tags: futures markets, interest rates, loans, market, trends) | Comments Off
in futures markets, in which individual contracts specify standard delivery months. the volume of each contract is available, along with the total volume of the market; that is. the total volume of all individual contracts. Spread transactions are not included in volume. This information is officially posted one day late, but estimates are available for many markets during the day. Total volume of crude oil is estimated even, hour and released to online news services.
Individual contract volume is important to determine the delivery. month that is most active. Traders find that the best execution fills are most likely where there is greatest liquidity. Analysts, however, have a difficult time assessing volume trends because there is a natural increase in volume as a contract moves from second month out to the nearby and traders shift their positions to the closest delivery month; there is a corresponding decline in volume as the delivery date becomes close. Looking only at the volume of one delivery month is equivalent to ignoring seasonality in an agricultural market.
Each futures market has its unique pattern of volume for individual contracts. Some, such as the interest rates, shift abruptly on the last day of the month prior to delivery, because the exchange raises margins dramatically for all traders holding positions in the delivery month. Currencies are very different and tend to trade actively in the nearest month up to one or two days before that contract goes off the board. While volume increases slightly in the next deferred contract, anyone trading sizable positions will need to stay with the nearby contract to the end.
Other than for determining which contract to trade, and perhaps the size order that the market can absorb, an analysis of volume as discussed in this series of posts must use total volume, the aggregate of all contracts, to have a data series that does not suffer the patterns of increasing and decreasing participation based on the coming and going of individual delivery months. When traders roll from the nearby to the next deferred contract, the transactions are performed as a spread, and those trades are not included in the volume figures. Because positions are closed out in one contract and opened in another. there is no change in the open interest.
The stock market equivalent to using total volume would be to add the volume for all stocks in a similar group. This would help smooth over those periods when the volume of one stock is very low If the group is not highly correlated in price movement, the end result might be a volume series that has very little to do with the stock you are trading.
Volume, Open Interest, and Breadth
December 3, 2009 // Posted in Uncategorized (Tags: chart analysis, futures markets, hedging, interest) | Comments Off
Volume pattern has always been tied closely to chart analysis in both the stock and tures markets. It is a valuable piece of information that is not often used. and one Vof the few items, other than price, that is traditionally considered valid data for the technician. Nevertheless, there has been little research published that relates this factor to futures markets; its popular use has adopted the same conclusions as in stock market analysts.
The stock and futures markets have two other measures of participation that are related, yet not the same. In equities, the large number of shares being traded allow for measurements of breadth. in the same way that the stock index has become a popular measure of overall market trend, the breadth of the market is the total number of stocks that have risen or fallen during a specific period. When you have the ability to view the bigger picture of market movement, breadth seems to be the natural adjunct to the index.
In futures, open interest is the measurement of those participants with outstanding trades; it is the netting out of all open positions in any one market or contract. and it gives an understanding of the depth of volume that is possible. A market that trades only 10.000 contracts per day, but has an open interest of 250,000, is telling the trader that there are many participants who will enter the market when the price is right. These are most likely to be commercial traders, using the futures markets for hedging.
TOPS AND BOTTOMS
December 1, 2009 // Posted in Financial market (Tags: credits, debt, insurance, loans, payday loans) | Comments Off
Most of the formations important to bar charting can be traded using a penetration of one of the support or resistance lines as a signal. The most interesting and potentially profitable trades occur on breakouts from major top or bottom formations. The simplest of all bottom formations, as well as one that offers great opportunities, is the extended rectangle at contract lows. Fortunes have been made by applying patience, some available capital, and the following plan:
1. Find a market with a long consolidating base and low volatility (with futures it should also have increasing open interest). When evaluating interest rates, use the yield rather than the price, and avoid currencies that have no base price; that is, they have no level considered low, but instead have a point of equilibrium.
2. Buy whenever there is a test of its major support level, placing a stop-loss to liquidate all positions on a new, low price.
3. After the initial breakout, buy again when prices pull back to the original resistance line (now a support level). Close out all positions if prices penetrate back into the consolidation area, and start again at step 2.
4. Buy whenever there is a major price adjustment in the bull move. These adjustments, or pullbacks, will become shorter and less frequent as the move develops. They will usually be proportional to current volatility or the size of the price as measured from the original breakout.
5. Liquidate all positions at a prior major resistance point, a top formation, or the breaking of a major bullish support line.
Building positions in this way can be done with a relatively small amount of capital and risk. The closer the price comes to major support, the shorter the distance from the stop loss; however, fewer positions can be placed. In his book, The Professional Commodity Trader (Harper & Row), Stanley Kroll discussed “The Copper Caper-How We’re Going to Make a Million,” using a similar technique for building positions. It can be done, but it requires patience, planning, and capital. The opportunities continue to be there.
This example of patiently building a large position does not usually apply to bear markets. Although there is a great deal of money to be made on the short side of the market, prices move faster and may not permit the accumulation of a large position. There is also exceptionally high risk and the increased risk of false signals caused by greater volatility. Within consolidation areas at low levels, there is an underlying demand for a product, the cost of production, government price support (for agricultural products), and low volatility. There is also a well-defined trendline that may have been tested many times. A careful trader will not enter a large short-sale position at an anticipated top, but will join the buyers who contribute to the growing volume and open interest at a well-defined major support level.
Market Noise
November 25, 2009 // Posted in Market Noise (Tags: debt, loand, market, morgage, stock index) | Comments Off
All markets have a normal level of noise. The stock index markets have the greatest amount of irregular movement due to its extensive participation, the high level of anticipation built into the prices, and because it is an index. This is contrasted to short-term interest rates, which have large participation but little anticipation and a strong tie to the underlying cash market. In comparison, long-term rates allow for greater movement away from the cash market. The normal level of noise can be seen as the consistent daily or weekly trading range on a chart of the DJIA or S&P When volatility declines below the normal level of noise, the market is experiencing short-term inactivity An increase in volatility back to normal levels of noise should not be confused with a breakout.
This same situation can be applied to a triangular formation, which has traditionally been interpreted as a pause within a trend. This pattern often follows a fast rise and represents a short period of declining volatility. If volatility declines in a consistent fashion, it appears as a triangle; however, if the point of the triangle is smaller than the normal level of market noise, then a breakout from this point is likely to restore price movement to a range typical of noise, resulting in a flag or pennant formation. Both of these latter patterns have uniform height that can include a normal level of noise.
Identifying Direction from Consolidation Patterns
November 20, 2009 // Posted in Uncategorized (Tags: business, cash, cash flow, Consolidation Patterns, market, money) | Comments Off
it is said that markets move sideways about 80% of the time, which means that directional breakouts do not occur often, or that most breakouts are false and fail to identify a new market direction. Classic accumulation and distribution formations, which occur at longterm lows and highs, attempt to find evolving changes in market sentiment. Because these formations occur only at extremes, and may extend for a long time, they represent the most obvious consolidation of price movement. Even a rounded, or saucer, bottom may have a number of false starts; it may seem to rum up in a uniform pattern, then fall back and begin another slow move up. In the long run the pattern looks as if it is a somewhat irregular but extended rounded bottom; however, using this pattern to enter a trade in a timely fashion can be disappointing and has resulted in the safe-but conservative technique of averaging in. Most other consolidation formations are best viewed in the same way as a simply horizontal sideways pattern,
bounded above by a resistance line and below by a support line. If this pattern occurs at reasonably low prices, we can eventually expect a breakout upward when the fundamentals change. Occasionally prices seem to become less volatile within the sideways pattern, and chartists take this opportunity to redefine the support and resistance levels so that they are narrower. Breakouts based on these more sensitive lines tend to be less reliable because they represent a temporary quiet period inside the normal level of market noise.
BASIC TRADING RULES
November 15, 2009 // Posted in trading rules (Tags: Financial market, market, trade, trading rules) | Comments Off
The simplest formations to recognize are the most commonly used and most important: horizontal support and resistance lines, bullish and bearish support and resistance lines, and channels. Proper use of these basic lines is essential for identifying the overall direction of the market and how it gets there. An understanding of these patterns will be helpful to computer-oriented analysts, many of whose techniques have been modeled after chart formation. More complex formations are likely to enhance good performance but cannot compensate for poor trend identification.
Once the support and resistance lines have been drawn, a price penetration of those lines creates the basic trend signal. The bullish support line defines the upward trend, and the bearish resistance line denotes the downward one. For long-term charts and major trends this is often sufficient, but frequent small penetrations of both long- and shortterm trendlines can be avoided by placing a band around both lines. A short signal occurs when both the trendline and the band have been penetrated. Because of the basic charting rule—-~’Once broken, a resistance level becomes a support level and a support level becomes a resistance level”-the original trendline (or a trendline plus and minus a band) can be used as a stop-loss. If prices penetrate the stop-loss point, then return to the original formation., there has been a false breakout and the original trendlines are still valid.
Individual Patterns
November 9, 2009 // Posted in Patterns (Tags: charts, credits, interest rates, loans, Patterns) | Comments Off
In addition to the broader patterns noted above, there are specific situations of short duration that have been noted by the chartist, including:
Gaps Spikes
Reversal days Thrust days
Cups and caps
Major and Minor Formations
Throughout the study of charting, it is important to remember that the same patterns will appear in short- as well as long-term charts. An upward trendline can be drawn across the bottom of a price move that only began last week; it can represent a sustained 3-year trend in the financial markets, or a 6-month move in coffee. In general, the longer the time interval, the more significant the formation. Contract highs and lows, well-defined trading ranges, trendlines using weekly charts, and head-and-shoulder formations are carefully watched by traders. Obscure patterns and new formations are not of interest to most chartists, and without the support of the traders, conclusions drawn from those formations have no substance. The basic charting course also includes interpretation of volume and open interest and a variety of rules for using the formations.