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Major divergence in Treasury bonds

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Wow! Are you watching the major divergence in the bond market this morning? In early morning bond market trading we saw lower YIELDS across the board. In the last two hours we've seen some major divergence take place. It started with the 30-year ($TYX.X), the spilled over to the 10-year ($TNX.X) and then flowed into the 5-year ($FVX.X).

Treasury bond YIELD screen capture at 10:30 EST

YIELDS began reversing higher with the 30-year (TYX.X) as bond traders started selling the longer-end of the bond market. Almost as if "Billy Bob Bond Trader" in the 10-year saw what was taking place in the 30-year, he started selling the 10-year. The only bond to still see buying is the very short-term 13-week. This is some major near-term divergence that hints that the "longer-term" view is diverging from the short-term. My thought here is that the longer-term looking end of the bond market isn't paying that much attention to today's economic data, but some market participants are instead moving some cash to the safer/less riskier 13-week. The "less risk" portion come in that a buyer in that bond can still hold to maturity short-term and not suffer a large capital loss should. Those buying/holding the 5-year, 10-year or 30-year have more capital risk longer-term that could be exposed to a price decline (higher YIELD) should selling continue as the bond market looks ahead to potential economic growth and future Fed tightening (raising interest rates). Traders should remember, the term "interest rates" are pertinent to Fed action, while the buying and selling in bonds impact "YIELD."

Working late last night...

Here's something I've picked up on in recent months as it relates to previous articles regarding putting yourself in the shoes of a market maker. It's a thought/pattern that has been working well for bullish short-term traders based on the thought that a market maker is getting a "buy side" bias and that his/her "bias" can impact a stock's price action.

Market makers getting "buy side" bias?

Why is it that the NASDAQ Composite (COMPX) and Russell 2000 (RUT.X) have been able to get above their 200-day moving averages, while the Dow Industrials (INDU) and S&P 500 Index (SPX.X) have not? I'm thinking it has something to do with a "buy side" bias that market makers may be taking with their inventory. Here's what has me thinking this way.

Any stock listed on the NASDAQ stock exchange has at least 4- letters. To me, this means a market maker is involved in bringing the buyer and seller together. If a buyer is present and there's not a willing seller, it's up to the market maker to "make a market" and provide liquidity for the buyer. Of course, the market maker sets his/her own price, but nonetheless, the Security Exchange Commission rules are that a market maker "must provide liquidity to the market under ANY market circumstances." The under "any market circumstance" could be bullish or bearish.

Now. The Russell 2000 Index (RUT.X) is full of 4-lettered stocks. There are lots of 1,2 and 3 lettered stock symbols too (either listed on the NYSE or AMEX), but recently I've noticed some peculiar action in four lettered stocks at levels where I've thought a market maker seems to back away from the offer/ask where market participants buy from.

This observation started with some past commentary and trade setup in shares of PeopleSoft (NASDAQ:PSFT) on a break above the $25.70 level for the next day's trading session (see Oct. 10th market wrap). The next day, shares of PSFT jumped 12.14% from its October 10th close. PSFT is NOT a component of the Russell 2000, but it is listed on the NASDAQ Composite. To buy or sell the stock, you have to go through a market maker and that's what I'm looking for. Market maker "buy side bias."

High Risk/High Reward potential

The following is a very similar type of trade with PSFT back on November 11th in it's bar chart. There's no guarantee that the same type of trading will happen, but under current market conditions, shares of 3D Systems (NASDAQ:TDSC) may have a near- term "buy side bias" from market makers.

3D Systems Corporation Chart - Daily Interval

With conventional retracement from a high to low, a trader can put themselves in the shoes of a market maker. From April to June, shares of 3D Systems (NASDAQ:TDSC) traded like a juggernaut as the stock surged from end to end of retracement. Looking back, it sure looks as if the $16.64 to $18.50 level was a range of liquidation. Recently, the stock looks like it visited a range of accumulation in the $8.81 to $10.66 range. Shares of TDSC show average daily volume of 50-thousand shares, but yesterday the stock traded over 392,000 shares (6-times average daily volume). There's an old trader's saying that "volume proceeds price movement." Since recent broader market action has been bullish and shares of TDSC are near the lower end of their range, this stock might be ready for a move higher.

If you were a market maker, and you had to provide a liquid market in this security, would you be a seller or a buyer? I'm thinking that a market maker has a "buy side" approach to the stock above the $10.66 level of retracement and would "back off" his/her offer should the stock trade above recent session highs of $11.50. At that point, a market maker may be looking over his/her shoulder at the $12.51 and $13.65 level. Any shorting done at current levels to provide liquidity for the market would be a risky proposition. Take a look at the 60-minute chart. This is where the "comparison" and trade setup looks very similar to that of PSFT of October 10th.

3D Systems Chart - 60-minute interval

An aggressive bull that has booked some profits in the recent market environment may want to take a look at TDSC near-term. The 60-minute chart and volume spike yesterday shows the bulk of the volume came in one hour. Since the stock is rather thinly traded with just 50-thousand shares average daily volume, I'm thinking that 300,000+ volume in just one hour was an institutional buyer of some sort. We never know for sure if it was a "new bull" establishing a position, or an "old bear" calling it quits.

All I know is that a market maker was involved in the transaction. It could be that a market maker did buy enough stock below the $10.66 in his/her inventory to be able to sell to somebody yesterday near the $11.25 average price. If that's the case, the market maker may still have a "buy side" bias in the stock above the $10.66 level. A market maker that didn't have any stock in his/her inventory to sell, could still have executed the transaction for the buyer (wouldn't want to pass up a 5-cent a share commission per share) by selling short the stock in order to provide a liquid market for such a large order. But doing so would put the market maker in a bearish inventory position near what could be the lower end of a trading range.

This type of "trading" or thinking isn't for everyone's account, but in the current market environment, we've been seeing some rather sharp reversals at levels where a market maker often times finds good bullish order flow as the broader market environment has turned bullish. If a market maker gets caught without any inventory, then they must either tell their institutional client to call someone else to fill their order (market makers don't like to tell their customers to go to the competitor) or sell short the stock in order to keep the customer happy and coming back for more orders.

Jeff Bailey
Senior Market Technician
Option Investor

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