Friday, 27 March 2009

S&P 500 Commercials Fading Rally

Not sure what to make of this market. I think the Commitments of Traders data from this afternoon is equally ambivalent. Derivatives traders in S&P 500 futures and options have gone bipolar this week. You'll recall my S&P 500 trading setup has been bearish for a few weeks. 

Last week, the "smart money" commercial traders flipped from bearish to bullish as they dramatically reduced their net short position. The commercial signal works with a three-week trade delay, but things were looking bullish. At the same time, small traders, who've been highly bullish since November in their futures and options positioning, had suddenly reduced their net long positioning last week. 

Well, things have changed. Today's data has caused both of my signals to flip. 

The commercial traders have suddenly ramped up their net short position again as the market rallied this week. They're clearly fading this bounce. Their net position as a percentage of the total interest has gone from 1.48 standard deviations above the moving average I use for the commercials signal to 1.92 standard deviations below the average. Their signal has flipped back to bearish after one week in the bullish column.

Meamwhile, the "dumb money" small traders have gone ahead and continued their capitulation that started last week. They're now 0.53 standard deviations below the moving average I use for their signal - down from 0.63 standard deviations above the average. That's caused my small traders signal to flip to bullish as the wrong-way retail crowd has also decided to fade this rally. Amazing.

Both signals work with a three-week trade delay. So where things stand right now is this: the current bearish signal will continue this coming week and the next and then - because the two signals don't agree - the setup goes to cash on the open of trading Monday, April 13.

As I noted in a comment to my post Wednesday, my current bearish S&P 500 position got stopped out that day after it hit my 8.82-percent stop level. That level comes from taking the average backtested trade gain and subtracting two standard deviations of the trade returns. The idea is to end the trade if markets appear to be acting outside historic norms. The largest past drawdown for this setup is 19.05 percent. So far, the setup loss wouldn't have been anywhere near that. But if the S&P 5oo rises to 903.43 during the life of this bearish signal - equal to a 19.05-percent loss for a bearish position - I'll invoke my Black Swan risk-control rule. That means I'd halt trading this setup for four weeks. The idea is to avoid markets when they are acting completely outside the historic norms seen in the backtesting.

On the other hand, if the S&P 500 falls below my entry price when the signal started (758.84),  I'll enter another short position for the duration of this bearish signal.

The COT data for gold is a little less eventful of late. The setup is in cash, but seems primed to enter a trade on the bullish side at the end of April. My signal based on fading the large spec total open interest remains in its fourth week of being bullish. That signal works with a seven-week trade delay. So if the other signal within this setup remains bullish, I'll go long in a few weeks.

Hope you have a great weekend. I'll update my portfolio page early next week with my recently closed S&P 500 position.


fr4nc01s said...

In my opinion, because of extreme compression in platinum vs. gold prices, gold bulishness has failed to increase price.
This is , I think, because of industrial sale of platinum.

It would be essential that as long as price ratio is less than 2:1 for platinum price to gold price, that we would benefit from your analysis on the platinum setups.

Until the platinum & gold setups BOTH go bullish, there is not reason to expect more than gold reaching intraday prices similar to platinum at the very best of cases.

Once in the last 6 months, I have seen gold intraday price surpass the platinum price, which 100% confirms the platinum getting liquidated... (maybe the auto ind. no longer plans on making that many break pads (made of platinum) and silencer...)


R. Craig Pritchard said...

Thanks for the work you do. I enjoy reading your report every week. I thought that I would add a comment about your 8.82% stop loss. I imagine that you are aware of this, but just in case, an 8% swing in the SP500 makes a pretty good stop and reverse trend following system. You can check out Robert Colby's work in "The Encyclopedia of Technical Market Indicators". In fact, this system would have performed very well in 2008. The point being, if you get stopped out of your system at this level, it may be a signal to look at the other direction rather than considering it to be an outlier.

Alex Roslin said...

Hi Craig,

Thanks for your message. You make a very good point. I neglected to mention it in this post, but I have noted in the past that I'd consider putting on a discretionary trade in the other direction if I get stopped out of a COT signal. Thanks for bringing this trading idea up.

Best regards,

Tim said...

Gold is being held in check because of the dollar. Gold is not pegged to platinum. In fact, platinum has such a small supply float out there that it is a lot more sensitive to non metal industry events say like the auto industry.
Platinum does not confirm gold nor vice versa although you will sometimes get "sympathy" movements in platinum.