Friday, 10 August 2007

COTs Flip to Bullish on S&P 400 Midcap (With An Asterix)

Phew - what a day. What a week. Friday was the perfect coda to all the week's mayhem. The Volatility Index back at the bear levels of early 2003. London's Financial Times Index with its head caved in. The three-month T-Bill rate crashing. Japan iShares crushed. You'd think a nuke had just gone off from the way the bears are dancing with glee.

One Forbes piece on Monday, titled The Crash of 2007, started out like this: "There is a really high probability that we are in the midst of a stock market crash, the first since 2002. This is a ridiculously dangerous prediction for a commentator to make." At least he got the second sentence right!

So do the wise little numbers in the Commitments of Traders reports agree it's a crash? Not quite. In fact, they just flipped to a bullish signal for the S&P 400 Midcap - my only new signal from Friday's report.

(See the "Trading Setups" link above for details about this setup and "How It Works" for how I trade my signals. For example, the S&P 400 setup has a trade delay of one week, meaning ordinarily I'd execute it for the open on Monday, Aug. 20. Also, see the table below for the full list of new and renewed signals.)

But there's an important caveat for this new signal that's making me interpret it with caution. The COTs reports failed to include data for the S&P 400 since the June 12 report because the number of traders reporting positions fell under 20. Thus, the data is missing for seven weeks.

Today's report shows the large speculators - the "dumb money" whom I fade (or trade opposite to) in my trading setup for the S&P 400 - dramatically slashing their net long futures and options position in this market as a percentage of the open interest. It's now at a low not seen since June 2005.

That, of course, is bullish. However, to get a bullish signal in my system, the large spec position must fall to a specific historically extreme point that in the past has shown statistically robust market-beating profitability. I calculate this point by backtesting numerous combinations of moving averages, standard deviations and trade delays and then subjecting them to tests of statistical validity.

The problem is if you're missing a bunch of data, those values get skewed. I think the super-low absolute net number is interesting, but as I've mentioned in the past there is virtually no correlation between the week-to-week COTs data and price action, so it's a bit weak to go on it alone. I may at some point consider a trade on technical grounds, though, until there is more S&P 400 data to even out the values in my spreadsheet.

Other developments from the latest COTs report:

- My composite U.S. equity indicator has fallen a tad from -0.10 to -0.12, maintaining the downer bias it's had since the May 22 report. This indicator is based on my setups for the four U.S. indexes in the COTs reports (the S&P 500, the Dow Jones industrials, NASDAQ 100 and Russell 2000). If we include the S&P 400, the reading jumps to 0.2, but as I've mentioned that figure is probably a little dubious.

A reading of 1 or -1 for this indicator would be a historic trading signal, meaning that, on average, all my setups just gave a buy or sell. The upshot is that, despite all the panicked crash talk, the COTs are advising us we're not at a major market turn here.

- Friday's data gives an 11th consecutive bearish signal for natural gas.

- We get an 11th consecutive bullish signal for the NASDAQ 100 index. This is the longest run of renewed signals for this market since the 17 bearish signals in a row between Nov. 2005 and March 2006, which predated the index's 17-percent tumble last year.

- A huge spike in large spec bullishness in the Japanese yen, which gave me a renewed bearish signal in this market.

Also, a note to self: My setup for the 10-year Treasury flipped to bearish for the yield with last week's COTs report. (That would be bullish for the note.) This setup calls for the signal to be executed with a one-week trade delay (that is, for the open Monday, Aug. 13).

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. You may find your answer already there. Thanks for tuning in, and good luck next week.

Next week: I'll try to find time to address the massive losses seen by some hedge funds that rely on quantitative computer models in recent weeks. What went wrong with those systems? Next week, I'll take a little look-see.

So far, it seems my COTs system has stood up not bad in its first major test to the downside, leaving me about even in Canadian-dollar terms since the selloff started. Mind you, I don't have trades on in every one of the markets for which I have signals at this point. That's partly because many of the signals predated the point when I developed these setups. At some point, I'll have to see how a portfolio based on following every signal would be faring.

New Signals*

-S&P 400 Midcap


Renewed Signals**

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

-Semiconductor Index, SOX
-Japanese Yen

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

-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)

-10-Year Treasury Yield (31-Jul-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)

-30-Year Treasury Yield (31-Jul-07)
-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.

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