Sunday, 5 April 2009

"Smart Money" Traders Betting Against Sucker Rally

An awful lot of people seem to think the worst is over for stocks. But a big time bomb may be close to detonating in the derivatives market. The "smart money" commercial traders - who are usually correctly positioned at key market junctures - have been massively fading the current stock rally.

Their net position last week in S&P 500 futures and options was 1.92 standard deviations below the moving average I use for my trading setup based on the Commitments of Traders data.

Friday's data saw them get even more net short. Their net position as a percentage of the total open interest fell to 2.28 standard deviations below the average. That's the most bearish they've been since early December - right before the market collapsed and took out its 2002 lows.

But the data isn't entirely bearish and is giving some mixed signals. While the commercials have been running for the exits, the "dumb money" small traders have also gotten bearish. My trading setup needs to see both groups of traders give the same signal before I'll actually bet money on a trade. And the little guy got super-bearish last week, which actually resulted in a bullish signal for the S&P 500.

Then, on Friday, the small traders
significantly increased their net long position. They went from 0.53 standard deviations below the average to even with the average on Friday. For my signal to flip to bearish, they need to hit 0.2 standard deviations above the average.

What does all this mean? Until the two signals agree, my setup for the S&P 500 will remain in cash.

This setup also has a three-week trade delay, and the two signals stopped agreeing with each other as of the March 17 COT report. So my setup goes from bearish to cash on the open Monday, April 13, and will remain so for the next three weeks, at least.

As for gold, the other market for which I've developed a COT trading setup, the signal remains in cash next week - its ninth in a row. But there's suddenly some bearish news looming over the horizon, after four weeks of potentially bullish posturing.

On Friday, the "dumb money" large speculators upped their total open interest by a sizable amount, bringing it to 0.69 standard deviations above the average, up from 0.55 standard deviations below the average the previous week. This sudden turn-around has caused my large spec open interest signal to go bearish, after four weeks in the bullish column. This signal works with a seven-week trade delay, so the flip-flopping signals don't have any bearing until the end of April.

What happens then depends on what the other signal that makes up my gold trading setup does. That other signal is based on fading the large spec net position as a percentage of the total open interest. (There is also no trade delay for this second signal - meaning the trade would be executed on the Monday after the signal.)

The large specs also seem to be on the move in their net positioning. Their position has gone from 0.74 standard deviations above the moving average to 1.12 standard deviations above. They haven't quite hit excessive territory yet, but they're getting closer. I guess the gold bugs are working overtime trying to get everyone piling in. So my signal based on fading the large spec net position remains bullish. But for the entire gold setup to go bullish at the end of April the large speculators have to put on the brakes. Or we could be in for continued volatility in bullion.

Hope you had a great weekend, and good luck this week!

TAGS: S&P 500, SPX, gold, COT, Commitments of Traders, derivatives, Black Swans, market timing, trading system development, CFTC, Commodity Futures Trading Commission, COTs Timer, Monte Carlo, out-of-sample testing, walk-around testing

13 comments:

alysomji said...

Was looking for your post on Friday and didn't see it.

Glad to see you were able to post something before the weekend ended. Always interesting to read your commentary.

Keep up the great analysis.

Tim said...

Alex,

Tim here. Isn't this weeks signal for the SP SHORT since the signal for setup 1 went to sell 2 weeks ago and the setup2 signal went to sell 3 weeks ago? Or do I have my delays wrong for the combined signal? I've got it going long next week and then to cash the following week?
Many thanks!
Tim

Alex Roslin said...

Hi Tim,

Yes, the setup is still short for one more week - though it did get stopped out of that position near the end of March. But for your more recent signals, are you sure you are using my current SPX setup? I've got the commercial traders going short the week of March 24, while the small trader signal went long the same week.

Regards,
Alex

Alex Roslin said...

Hi Alysomji,

Apologies for the late post. My real job kept me away Friday.

Regards,
Alex

Tim said...

Yes, I am using your new setup - I am just using different stops. Actually, I am not using any stops - I am delta hedging on a weekly basis. Little more volatile but fine none the less.

And what's this malarkey about you having to work your "real" job? Don't you know that this blog is your real job? Just kidding.

Tim

Alex Roslin said...

Hi Tim,

Did you sort out the different signals? Email me your spreadsheet if it's still not resolved.

Regards,
Alex

Dan T. said...

Agree with alysomji. I was looking forward to your take on the movement of commercials to a short position.

Thanks for the work on the website.

Tim said...

Thanks for the offer Alex, and for all of your help thus far. I wasn't in cash because I am using different stops metrics.
The signals are all current with the ones you are using also.

Although I haven't tested it yet (and my programmer is AWOL), I am trying to use stops based upon the following:
any moves that are greater than 1sd of the previous 50ma.

Alex Roslin said...

Hi Tim,

Glad to hear it. Please do keep me posted. I had some potentially good results from a price-based signal based on the slope of the moving average, in the 50-week range. Mind you, still not as good as just relying on the COT signal. But perhaps still worth playing around with.

Regards,
Alex

avocade said...

With the recent 20% jump in financials and ~4% overall, is your Black-Swan rule almost in effect? It seems the market is really off right now, and the VIX is sinking below 40 for the first time since early autumn.

Alex Roslin said...

Hi Avocade,

Thanks for your question. The Black Swan Rule would have taken effect for the SPX setup if the index had risen to 903.40. (See my post from March 27 for more details.) The setup goes to cash on the open of next week's trading, and SPX is still well above that point. (I got stopped out March 26.)

The action in the financials doesn't have any bearing for this setup. It might for a setup based on trading financials using the COT data for the Eurodollar contract, but that's still on my to-do list.

As I pointed out in response to another reader a few days ago, getting stopped out of that SPX signal suggests it might have been a good time to trade in the opposite direction (i.e., long). That's what I've been doing in discretionary trading, with positions in Ford, RSX, JJC and PTM and HQU - though those are all very short-term positions, which I might not hold for more than a few days more. Not recommendations for anyone out there!

Regards,
Alex

Ray said...

Alex, will you be posting another update today or tomorrow?

Thanks,
Ray

Alex Roslin said...

Hi Ray,

Sorry about the delay. I've downloaded the data and updated the spreadsheets, but just haven't had a chance to write up a report for the new data. I'm on a holiday schedule for the next couple of days and also took some time to finish up analysis of the COT data for crude oil and have found some very interesting trading setups I'll announce shortly and start trading. I'll update the signals shortly.

Regards,
Alex