Do markets decline in value at a faster pace than they rally? The question is put to the test using the Chicago Board of Trade Treasury bond futures contract.

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Nearly all market analysts agree that the bull market in bonds began in 1981, when the price of the Treasury bond futures contract bottomed at 55-05 (Figure 1). There is, however, an array of disagreement as to when or if the bull market ever ended. In my opinion, the bull market for bonds ended in October 1993, when the futures contract peaked at 122-06. The primary reason for my bearish view? Since the October 1993 peak, the Treasury bond has declined at a faster rate than it has advanced. For example, during the October 1993 to November 1994 selloff (Figure 2), the average daily rate of change was -2.94 ticks (one tick is 1/32, or $31.25 for one T-bond futures contract).

Those who disagree with my bearish view have countered by saying that markets naturally decline faster from highs than they advance from lows so those stronger selloffs were only natural occurrences, and thus, they were not indicative of the direction of the price trend. The adage that markets break faster from highs than they rally from lows is accepted by most traders and has been cited by many analysts. But does that tendency actually exist in the bond market? Or is this widely held belief a myth that would not stand up to rigorous historical testing? To determine whether this belief is supported by evidence, I employed a five-step approach. First, to identify reactionary highs and reactionary lows I used a moving average channel (Figure 5). When the market closes below the moving average of the low prices of the past 10 periods, the highest closing price when the market was above that average is considered to be a reactionary high. Then when the market closes above the moving average of the highs of the past 10 periods, the previous lowest closing price when the market was below that average is a reactionary low. The identification of successive highs and lows continues this way as the market closes below and above the channel of moving averages.

FIGURE 5: 10-PERIOD MOVING AVERAGE CHANNEL. When the market closes below the moving average of the lows of the past 10 periods, the highest closing price when the market was above that average is considered to be a reactionary high. When the market closes above the moving average of the high prices of the past 10 periods, the previous lowest closing price when the market was below that average is a reactionary low.

The result of the daily test supports the belief that the T-bond breaks faster from highs than it rallies from lows. The result of the weekly test, however, contradicts that belief. However, given the small amount of bias in each result, it is impossible to prove from these figures that the T-bond has a natural tendency to break faster from highs than it rallies from lows or vice versa.

Excerpted from an article originally published in the September1997 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 1997, Technical Analysis, Inc.

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