Hit the Hanging Man with the Hammer: LQD vs JNK

• Posted by Greg Harmon
• on January 20th, 2011

Below is the ratio chart for the iShares Investment Grade Corporate Bond Fund (Ticker: LQD) against the SPDR Lehman High Yield Bond ETF (Ticker: JNK). Note that it has been in a descending channel since September. This implies that traders are stretching their credit criteria for yield, thus tightening the difference between the two.

During this downward move, the Relative Strength Index (RSI) has maintained a bearish level for the entire run. Currently the RSI is pointing down and the Moving Average Convergence Divergence (MACD) indicator looks like it may cross lower, also bearish. But the ratio also stretched outside of the Bollinger bands today and printed a potentially bullish Hammer candle. This Japanese candlestick pattern with a test lower and then a move back higher can often signal a reversal in a downtrend. Is it set to continue lower or is it ready to reverse, if only for a few days? Let’s dissect it into the two pieces and look at the individual charts. Below is the chart for LQD.

LQD has traded lower over the last few days after a strong run higher. But is also printed a Hammer candle yesterday. The Hammer needs to be confirmed the next day before a trade is entered, but if it is then expect a rise to the 100 day Simple Moving Average (SMA) at 109.68. This is not a given as the MACD is moving lower currently but the RSI is near the mid line where it has recently held. Next look at the chart of the JNK.

This chart has been hovering near the technically overbought line of RSI at 70 for some time. It has a MACD that is crossing but from a Japanese Candlestick perspective it printed a bearish Hanging Man candle yesterday. Should it be confirmed and fall, there is support at 39.60 and then the 50 day SMA below that at 39.38.

Trade Idea: Long LQD vs Short JNK at a ratio of 2.7:1, with a target of 2.75:1 and a stop at 2.685:1

So from the Japanese Candlestick perspective, assuming confirmation, the reversal in the ratio makes sense, and one could grab the LQD Hammer and know the JNK Hanging Man down off of its perch.

Trade’m well.

(As always you can see details of individual charts and more on my StockTwits feed and on chartly.)

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