By William Kurtz

Treasury Bond prices have been in a rising major trend since July 2007. They appear to have topped out on January 23, and have declined slightly since then. Having in mind that Japanese Candlestick patterns which form in the price bars are often accurate in forecasting reversals of major trends, I examined recent price history of the 10-year Treasury Notes (as proxies for the Bond/Note/Bill complex) in an effort to discover whether there have been any patterns that have been left behind which might give us some insight as to the probability of the next significant price move in the Bonds, Notes, and Bills. The quick answer is Yes, we have found Candlestick clues which indicate that the next probable major move is Down.

The January 22 Daily chart of the 10-year T-notes is a "High-Wave Spinning Top" in Candlestick terminology. This pattern is an Alert signal, cautioning that a trend reversal may be imminent. Likewise, the price action on January 22 was an "Island Top" in the making (as of that moment) in "Western" technical analysis. An "Island Top" is characterized by a gap up between the high price of the previous day and the low price of the subject day. The pattern is complete if prices gap down on the day following the subject day. Since, obviously, the following day had not yet occurred, the incipient "Island Top" pattern was not yet complete as of the close of trading on January 22. Even so, the gap up put us on notice that an Island Top might form. If an Island Top does form, it is regarded as a bearish warning signal.

The next day, January 23, is much more significant. The Island Top was never completed, because prices did not gap down. Rather, the "real body" of price action on January 23 completely engulfed the "real body" of price action on January 22. ("Real body" means that particular portion of the total price movement of the chosen time period, such as a day, which is encompassed by the price area between the open and the close). Furthermore, January 23 was an "up day," wherein the closing price was higher than the opening price. When this pattern appears at the end of a long uptrend, it is known as a "Last Bullish Engulfing" pattern; and whereas from a visual inspection one could conclude that the bull market is continuing strongly, the opposite conclusion is drawn: namely, that it is a warning of a reversal of trend to the downside. That is certainly counter-intuitive, and is explained as a "last hurrah" or "blowoff," as a result of which all bullish energy has been expended and therefore prices have nowhere to go but down. Like all Candlestick patterns, the "Last Bullish Engulfing pattern" is not foolproof; but it "works" often enough that we pay attention to it when we see it.

The "Last Bullish Engulfing" pattern was also confirmed by the Weekly chart of the 10-year Treasury Notes, which shows a "High-Wave Spinning Top" pattern. This particular pattern is also considered to be a warning of a possible reversal of the major trend.

So far, the evidence is in the pudding: In the present case, prices closed lower on the day following the Last Bullish Engulfing day, and since that time until today they have continued approximately sideways. We will be very interested to see what happens next.

We recognize that, as is the case with any technical analysis, this is an exercise in probabilities. No Candlestick pattern has a perfect record. Even so, we know from experience that they are often right on target. In the present case, our forecast is that prices in the Bonds and T-notes will likely decline in the relatively near term.

William G. Kurtz Jr. http://www.candlewave.com/candlewave.htm January 31, 2008

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