Monday 8/4 Talking Techs

By: Matthew Graham •

Candles

A style of technical charting which you may have seen on other MBS sites is Japanese Candlestick analysis.  Google search it if you're curious.  It's been gaining popularity in the west and is still relatively young to the western world.  True believers think there's no substitute.  Depending on how it's used and interpreted, it can be very reliable.
 


What the heck are you looking at?

Simply put, each candle has a "real body" which is the rectangular portion, and "Shadows," which are the wick-like lines emanating from the top or bottom.  If the candle is white, prices gained on the day, black=opposite.  The top and bottom of the "real body" are the open and close values (black candle, open =top, white candle, open = bottom).  The shadows are simply the top and the bottom of the trading range.  They can be used Quarterly, monthly, weekly, daily, hourly, "minute-ly," or even every five seconds!  The moral of the story is that candle patterns repeat themselves no matter the time frame.  Daily, hourly, or minute by minute candles are the most popular.  We will usually look at daily and hourly, but will always specify.

The graph above is a daily chart with each candle representing a day starting about a month ago on Jun 27th.

Notice we see a solid 'bottoming' towards recent weeks.  Any time there is a very regular implied line (true for almost all techs), such as the bottom red line we see, it is indicative of a trend.  Although there is not enough space to post a big enough graph to show it, the broader trends occurring over the course of the previous year support the probability that June was a market bottom and we should have a sober and measured improvement (aka 2 steps forward, one step back!) into the winter.  There are always exceptions to historical trends, but this phenomenon has occurred with "more-than-coincidental" regularity throughout history.

Now, the technician might stop there, but as we discussed, let's mix in at least an even amount of fundamentals, such as:

  •  loan quality is increasing due to pull back in underwriting leniency
  •  catastrophic factors are decelerating in the housing market (not DECLINING, but DECELERATING)
  • more stock market weakness is on the horizon (generally good for bonds)
  • spreads are historically wide (set's the stage for a tightening as quality proves itself.

So considering these fundamental factors with the technical suggestion that we should improve and we can begin to make a better than 50/50 call that rates should improve SOME time, but at times we'll have to endure high volatility in the process, or worse yet, the risk that this is one of the years that breaks the trend.  Inflation is a key player in that story.  Just remember that if you can make the right call on the market 60% of the time, you'll win big in the long run (that, indeed, is the purpose of this website... A more informed and calculated risk), but 4 out of ten times, you'll lose. 

Back to the graph...

The top red line is inserted to show a slight decrease in recent highs (notice 7/24 through 7/30).  By contrast, the rise in lows from 7/22 through 8/1 is much steeper.  That earns that pattern the designation of "ascending triangle" aka "bull triangle."  Guess what, that's good for rates!  There are several kinds of triangles and sometimes they are symmetrical.  In all cases, AS SOON AS THE PRICE CURVE BREAKS OUT OF THE TRIANGLE LINES, THAT IS THE LIKELY DIRECTION OF CONTINUATION.  Read that again and absorb it.  It happens that way much more frequently than not.  Again, it's a scientific guarantee, but simply a "probability booster."  As we discussed, the direction of the breakout is important.  Not only does this triangle break out for the positive, but the triangle started as a Bull Triangle anyway, indicating the probability of the observed result.

Let's take a look at a more detailed explosion of the triangle section in the first graph.  There are actually two ways to do this with candlestick charting, either by close price or by high/low price.  Both are valid, and both usually agree.  We can establish a triangle any time we have at least 3 reversals from a starting point, which we have starting on 4/24 (reversal = alternating gain/loss days, so on a candle chart, we're just looking for "white, black, white, black, white, etc..."

Brace yourself for our most confusing graph ever:

 

 Ok, what are we looking at?!

Consider the previous paragraph and reexamine.  The light blue line is the curve if drawn with close prices, and the orange line is the drawn with highest and lowest prices.  Both have similar shapes and suggest similar bullishness.

The red line is the widest possible interpretation of the triangle, based on intraday highs and lows.

The white line is slightly tighter as it is based on daily highs and lows, but the shape is similar.  

So, the blue line will always "bounce" in between the white lines and the orange line will always bounce in between the red lines.  As you can see, not only are both triangles steeper on the bottom (bull triangle), but the price lines break out of both of them on the upside (also bullish).  Usually the intraday and daily price line triangles will agree, so if they didn't, it could be cause for concern.  But taken into consideration with fundamentals and the broader trend suggesting that summer tends to be the bottom for MBS, it's a promising sign, and one of the many factors we consider in recommending floating right now even as others rush to lock.

Just remember that a decision to lock must ALWAYS be considered near your lock cut-off with respect to this website.  Day over day lock recommendations are not something to be taken lightly as SO much can happen day over day.  We rarely take a position on longer term market movements.  When we do, it's only to suggest what past precedent, current climate, and technical data show.  Tomorrow could always break the rules or trends.

This is why we almost always start the day with a float recommendation.  Because if you are reading the site in the morning, and you haven't locked yet, there's not a lot you can do to lock before lenders release rates.  And it is usually a safe bet to start the day out floating as we can almost always be far enough ahead of lender reprices to get you out of trouble.  So use this website MOSTLY for intraday decisions.  But of course we will attempt to give you enough data to guide you in your day over day and week over week lock/float decisions, but just know that whereas we can be right almost 100% of the time on intraday movements, the probabilities on the time frames that we are currently discussing (i.e. "into the winter") are much more uncertain.  When we reference broad time frames, we're trying to give you that edge that puts you over a 50% chance of success. 

Bottom line is that these technicals look good except that Friday's candle represents a formation called "dark cloud cover" which is a bad sign.  That's the problem you'll almost always encounter with technicals: one strong indicator will be bullish while another is bearish.  All we can do is weigh the evidence for either side, BOTH TECHNICAL AND FUNDAMENTAL, and execute our best option based on our time constraints and price sensitivity of the loan.

We'll try to get to some more technicals by and by (unless we get a bunch of angry emails... Either way, it will have it's own section on the new site).

UPDATE: interestingly enough, an intraday triangle has formed while this was being typed.  It was a a parallel, meaning the breakout area would be the indicator.  Sadly, it has broken out with a bearish disposition, so stay tuned for intraday movement.  But again, in the longer run, technicals are showing promising trends.