It is common knowledge that US Treasuries reached record-high demand levels on July 25, 2012. That’s when the 10-year Treasury note yield dropped to 1.382%, the lowest level in more than 200 years. Investors fled to ultra-safe Treasuries in response to the euro-zone debt crisis. For the alert trader and investor, these episodes of panic frequently offer a window of opportunity to enter into a low-risk position. Professional traders at leading hedge funds use technical analysis to identify such low-risk levels before the move happens. They then wait patiently, and when the panicked buyer pays a handsome price, these smart fund managers cheerfully sell their holdings. One of the most effective tools for timing the trade is Elliott Wave Analysis. This article will demonstrate how someone could have identified many such attractive trading levels over the last few years.
Let us start with the first move down in the 10-year note yields as shown in the chart above. Elliott Wave theory says that when a five wave movement is completed, we should look out for a correction. Frequently, such corrections recover to a Fibonacci ratio of the prior move, and 50% is one such ratio. At the point marked “A”, a five wave move finished, and we got two tests of the same level. A failure to break below the prior low, especially when a five wave move was seen to have ended there, is a strong signal for the technical trader to act. In this case, we saw bond yields rally by almost 50% of the prior drop.
As per Elliott Wave theory, the third step down is often related to the first wave. As can be seen from the second chart above, Wave C went just a shade over a 100% measure of Wave A. We also got a second test of the low that held. Once that low was established as significant, bond yields rallied sharply again, this time reaching very close to a 61.8% retracement of the whole ABC move down. You are right! 61.8% is another useful Fibonacci ratio that traders always keep an eye on. A second test of that high failed to take the yields up, and it was time to look for another move down. See the next chart below.
The relationship between alternate waves is well established in Elliott Wave literature. When a mini-five-wave down move reached the 50% projection of the prior ABC down move, bond yields recovered swiftly again. In the next chart, I am going to zoom into the second set of ABC moves, so that you can clearly see two things. First, that Wave C is once again related to Wave A, and secondly, there are five minor waves making up Wave C.
The above charts present you an Elliott Wave Analyst’s case that we could have potentially seen a significant low in bond yields at the 1.381% levels. How will a professional trader use this information? First of all, he/she will always acknowledge that no one knows the future. However, technical traders follow a model. Elliott Wave analysis is one such model. The model tells us that there is a high probability that we have seen a significant low. As illustrated in the first few charts above, when the markets make a second test of a significant high or low, and it holds, then it adds considerable weight to the analysis. A technical trader will now be alert for a retest of the recent low. That retest may or may not happen. But suppose it does happen and the market is unable to take out that low. Then it will present an incredible opportunity to go long on yields (or short the bonds) with a nearby stop loss. The risk/reward ratio will be too attractive for most professional traders to pass.
This is just one case study of the usefulness of Elliott Waves to the trader. The model works just as well in any well-traded asset class.
Check out my other Forbes articles covering equity markets. I also have a widely-followed blog, WaveTimes, that covers a variety of other markets, and have written an immensely popular book “Five Waves to Financial Freedom.”
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