Goal: Understand how bond prices historically precede or align with S&P500 turning points.
“This is a trend-following mechanism that works by taking the range (each day’s high minus the low) for the past seven days and then multiply- ing this average range by a factor usually in the 2.0 to 3.0 value. This is an amount of volatility, which is then subtracted from the highest closing price in the uptrend. What is created is a filter band above and below the current price. Should the stock price close below this point the assumption is the trend is down. When prices have been below this volatility filter and close above the volatility filter the trend is then considered to be up. This can be used on daily or weekly charts.
It is my observation that this volatility index, when applied to the bond market, gives us an indication that interest rates have bottomed. My assumption is that if the trend in interest rates has bottomed—that is, the bond market is beginning to rally—then stocks should shortly fol- low thereafter. Figure 4.7 shows the bond market on a weekly basis with the volatility stop. Our trading rule would be to look for a point to buy stocks when the weekly close of the bond market is above the volatility stop. This should take place during a time stocks have been declining or a bear market has been in existence. We are using the trend of bonds to buy stocks. When the weekly close of bonds is greater than the volatility stop we’ll mark off a point to buy stocks.
Please understand it is used only for entering the market—this is not a sell short indicator.”
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