Friday, 3 August 2007

COTs Flip to Bearish on 10-Yr Treasury Yield, Neutral on 30-Year Yield

Holy smokes - what a devastating close for the bulls! Hope you fared okay. Did my DUG UltraShort Oil & Gas position come back from the dead, or what? SDS UltraShort S&P 500, you're not looking too shabby, either, my friend.

Interesting new signals from today's Commitments of Traders report. My setup for the 10-year Treasury has flipped to bearish for the yield. (That would be bullish for the note.)

The setup is based on trading on the same side as the small traders when they hit certain historic extremes in their net futures and options positions in this market. In this case, the small traders are at a bullish extreme that in the past has led to good trading signals.

My setup calls for the signal to be executed with a one-week trade delay (that is, for the open Monday, Aug. 13).

As well, my setup for the 30-year Treasury has flipped to neutral, which means going to cash in this market. (Trade delay is zero, which means execution for Monday's open, Aug. 6.) This rather unique setup is based on following two groups of traders when their signals concur. In this market, I fade the commercial traders and trade the same side as the large speculators.

I know, I know, it sounds nutso. We're always told the commercials are the "smart money" while the large specs are the dumb-asses with the poor market intelligence. Well, surprise, surprise, do a little backtesting and system validation, and you'll find that's not true in all markets.

In this case, the commercial traders in the 30-year Treasury futures and options have just hit a bearish extreme that my system tells me has led to good bearish signals for the yield (i.e., bullish signals for the bond). Because the large specs are still on a bullish signal for the yield, this means the two setups don't concur. So we go to cash in this market.

In other COTs developments, I got another whack of bearish renewed signals for the oil and natural gas sectors. (See the table below.) And in equities, my composite U.S. equity indicator has improved ever so slightly from -0.18 last week to -0.1 this week. It's been hovering below zero, in fact, since May 25, with the exception of one week in mid-June.

This indicator is based on my setups for the four U.S. indexes in the COTs reports, not including the S&P 400, which for several weeks hasn't registered enough traders to get its data into the weekly COTs reports issued by the Commodity Futures Trading Commission. A reading of 1 or -1 means a historic trading signal and would mean that, on average, all my setups just gave a buy or sell.

So we're nowhere near such a cosmic positioning in the COTs data at this point, despite the market turmoil we're seeing.

Confused about all this? Before you write in with your questions, see my "Trading Setups" and "How It Works" links above for details on the COTs and how my system based on these magical reports works. It usually takes me a while to get back to everyone because of the volume of emails.

New Signals*


-10-Year Treasury Yield

-30-Year Treasury Yield

Renewed Signals**

-13-Week Treasury Bill Yield
-Natural Gas***

-Crude Oil, Light Sweet***
-S&P/TSE Canadian Energy iUnits ETF, XEG.TO
-Oil Service Holders, OIH
-Semiconductor Index, SOX

Existing signals (date of original signal in parentheses)****

-30-Year Treasury Yield (3-Jan-07)
-10-Year Treasury Yield (17-Apr-07)
-S&P/TSX Composite (15-Aug-06)
-NASDAQ 100 (27-Mar-07)
-Dow Jones Industrial Average (20-Mar-07)
-Russell 2000 (1-Aug-06)
-Silver (3-Jul-07)
-Gold (29-May-07)
-US Global Investors Funds US Gold Fund, USERX (12-Jun-07)
-S&P/TSE Canadian Gold iUnits ETF, XGD.TO (22-May-07)
-Gold Bugs Index, HUI (29-May-07)

-13-Week Treasury Bill Yield (27-Feb-07)
-S&P/TSE Canadian Energy iUnits ETF, XEG.TO (3-Apr-07)
-Oil Service Holders, OIH (3-Apr-07)
-S&P 500 (26-Jun-07)
-NASDAQ Composite (26-Dec-06)
-Semiconductor Index, SOX (20-Mar-07)
-S&P 400 Mid Cap (3-Jan-07)
-Nikkei Average (19-Dec-06)
-Soybean Oil (11-Nov-06)
-Copper (10-Apr-07)
-Canadian Dollar (10-Apr-07)
-U.S. Dollar Index (3-Oct-06)
-Japanese Yen (2-May-06)

-Crude Oil, Light Sweet (3-Apr-07)***
-Natural Gas (27-Mar-07)***

* For an explanation of what I do after a new signal, click “How It Works” above.
** A “renewed” signal is when a market is already on a bullish or bearish signal, and traders again register an extreme net trading position in the same direction. I normally ignore renewed signals unless I don't already have a trade on in this market. I haven't studied the profitability of trading on renewed signals.
*** See my special caveats for my Crude Oil and Natural Gas setups (click “The Trading Setups” above and check the table footnotes).
**** The date in parentheses is the date of the COTs report that gave this signal - not the date my system called for the trade to be executed (which can be up to five weeks later). The existing signals are often several months old and are listed here as references, not trading recommendations.


Anonymous said...

I'm a novice, so here are a few questions:

- I've read elsewhere the COT report is delayed for 2 weeks. Is this true? If it is, then by the time you get the report that the Commercials turned bearish (for example), the damage may have been done.

- If even a novice like myself has heard of the COT report, I guess most traders do long ago. And if the Commercials have had such a good record, wouldn't most experienced people just follow the Commercials, since it's such a high probability setup for much less work? It's hard to believe that people would disregard the Commercials' position (knowing their great success) at their own perils. But what would happen when most people tilt in one direction?

- The COT report also shows the small(retail) traders and large specs (trend-followers, hedge funds) positions. Let's just ignore the small traders. But the trend-followers and hedge funds are no dummies. Why would they ever trade against the Commercials?

I can believe that people may not like others' trading systems, and rather use their own's. But if the Commercials have been right most of the time, then after a while, no matter how stubborn they are, hedge funds and trend-followers would realize this fact, and change their tactics to follow the Commercials instead.

Some of the famous trend-followers are John Henry, Ed Seykota, Richard Dennis, etc., and famous hedge fund traders are Paul Tudor Jones, George Soros, Druckenmiller, etc. They are not billionaires for being dummies. Yet they trade independently against the Commercials, and are still huge winners and get extremely rich.

- Finally, how would you know for sure what the Commercials, or others, actually do in Futures markets? Are they really buying/selling or hedging? Could it be that they short stocks and long the Futures to hedge their bets, or vice-versa?

- Could it be that the Commercials have been shorting the cash market (stocks) more and more since the last 2 weeks, and thus hedge their positions by going long more heavily in the Futures?

The reason I'm asking this is that you seem to arrive at your final analysis by rigorous back-testing, while a few other blogs that follow the COT really believe that following the Commercials' positions in any market is as close to the Holy Grail as it could be. However, I don't believe this is the case.

Some of these blogs have been mentioning that the Commercials kept increasing their long Futures positions the last few weeks, so it's a good reason to be very bullish on stocks. Although they have been wrong for more than 2 weeks, they consider it's only a paper drawdown, and not real loss, and believe that the market will eventually go right back up. It may, but I wouldn't bet the farm on it. What if the Commercials are just hedging their short stock bets by going long the futures?


Alex Roslin said...

Hi Ken,

Thanks for writing. Here are answers to your questions:

- The COTs report isn't delayed two weeks. The data is good as of the Tuesday before the Friday release date.
- The commercials haven't had such a good record in many markets. As well, it's not simply a matter of following the commercials or any other group for that matter. One has to figure out at what point the traders hit specific historic extremes that made for good signals in the past. That involves backtesting and system validation.
- The large specs often - but not always - seem to use trend-following strategies. Thus, they may trade against the commercials when the commercials are using contrarian strategies. Both types of strategies can be profitable.