Tweaked S&P 500 Setup Bearish

Spent the weekend taking another look-see at my trading setups based on the Commitments of Traders data. I wanted to apply a few new optimization techniques to the existing setups made easier by some additional automation I've added to my Excel spreadsheets. The results are on the latest signals table. I've made slight adjustments to each of my three setups for the S&P 500, gold and crude oil. The backtested returns are a little weaker, but the key measures of robustness I'm looking at (see the far right hand part of the table) are superior for these new setups. The current signals for gold and crude are the same as for the old setups, but my S&P 500 signal is now bearish for its second straight week. I've also just posted a new S&P 500 spreadsheet at my DIY guide page so you can take a look for yourself.

Gold Good to Go

What a bizarre close. As Stephen Vita has been noting at his AlchemyOfTrading site (a truncated free version of which is available here), the S&P 500 has come up again to resistance at a key DeMark Setup Trend line just below 870 and, near the close today, it bounced down abruptly from there. On the other hand, the HGX Housing Index has broken out nicely above TDST daily line around 90. Next week should be interesting. The Commitments of Traders data is equally ambivalent about equities and crude oil, but it's finally giving a new signal for my trading setup for gold. (See my latest signals table for the details based on this afternoon's weekly COT data release.) Here are some highlights based on today's report:

- Eleven weeks in cash are at an end for my gold setup. It's gone bullish with execution for the open of Monday's trading. I can't tell how long the signal will stay bullish, but things look good for now. The wrong-way large speculators are nowhere being excessively long, which is bullish. Their net position as a percentage of the total open interest actually fell this week to 0.34 standard deviations above the average I use for their signal, down from 0.62 standard deviations above last week. They need to hit 1.9 standard deviations above for that signal to go bearish - so all clear for now. This signal works with no trade delay - so it's the unknowable question mark when it comes to trying to see into the future of this market beyond the coming week.

The other signal that makes up my gold setup has a seven-week trade delay. It went bullish the week of March 3 and has been so ever since, with the exception of a single week (the week of March 31). This signal is based on fading the large spec total open interest (long plus short positions in futures and options). These guys' open interest level is comfortably bearish right now - 0.51 standard deviations below the average, up a little from 0.82 standard deviations below the prior week. So unless the large spec net long position suddenly explodes, we can probably expect a bullish signal lasting a few weeks at least. Of course, with today's markets, all guesses are worthless pretty much as soon as they're written down. So ignore what I said.

- Crude oil: My setup for crude is in cash for a single week starting Monday, then goes back to bullish for the open of trading the week of May 4. Small traders, who are the "smart money" in this market (believe it or not), have been bullish on crude since early December. The commercial traders, paradoxically also the smart money, have been a little more uncertain. But the week of March 31 they really got hot on crude futures and options, moving the commercials into the bullish column. Starting May 4, the setup will remain bullish for two weeks.

- S&P 500: The smart money commercial traders remain highly dubious about the market rally. Their net position as a percentage of the total open interest has fallen to 1.63 standard deviations below the average, down from 1.02 the previous week. Meanwhile, the small traders, whom I'm fading in this setup, are quite a bit more bullish than last week's paroxysm of gloom. They've come up to just 0.01 standard deviations below the average, up from 0.50 standard deviations below. Despite this, they remain pretty far from being excessively long, too. So they're still on a bullish signal, while the commercials remain with their bearish call. The setup overall is therefore in cash again, for a third week.

I should note that if I had placed a trade based just on the commercials bearishness, I'd be out of a good chunk of money. It's an example of something I've found pretty consistently in looking at this data: a signal based just on one group of traders is typically a lot less reliable than one using two or more traders, when they agree.

Hope you have a fabulous weekend, and hope to see you here next week with a portfolio update and a new trading setup for the BKX Bank Index, based on the three-month Eurodollar COT data.

TAGS: SPX, S&P 500, NASDAQ 100, gold, BKX, Bank Index, crude oil, COT, Commitments of Traders, derivatives, Black Swans, market timing, trading system development, CFTC,Commodity Futures Trading Commission, COTs Timer, out-of-sample testing, walk-around testing 

Apologies... Latest Signals

Apologies for my late post on last Friday's data. I just got back from a trip away and didn't have access to a computer. I've now updated my latest signals table, and as you can see there weren't any new signals from last week's data for my trading setups based on the Commitments of Traders reports. But that's not to say there weren't some interesting developments in the latest data. I'll post a more detailed look Wednesday and see you back here Friday with the word from my setups based on the next data release, including a new signal for my crude oil setup and possibly for gold bullion, too. Good luck the rest of this week!

Crude Data Warns of Volatility But Suggests More Upside

Crude oil might be due for a little more upside, but my new trading setup for black gold is also warning of possible volatility in coming weeks. I've just posted the latest signal information and backtesting results for this new setup on my latest signals table.  The setup beat the market hands-down during the bull and bear markets of 2003-08, with a compound annual return of 29.99 percent (including 0.2-percent trade friction per trade) while being in the market less than half the time - compared to a gain of 3.13 percent for crude. While crude crashed 57 percent in 2008, this setup gained nine percent through being short or in cash. 

Most recently, the setup has been bullish for the past four weeks - its first time being long since Oct. 2007. It will remain bullish one more week, then go to cash for a week and go back to long for two more weeks after that. The parameter details for the setup are all in the notes to the latest signals table. I haven't posted a spreadsheet for the setup, but might do so eventually. You can still create it for yourself using the values I've listed in those notes and plugging them into the S&P 500 spreadsheet I've posted on my DIY page. Please be careful to read all my disclaimer information before attempting to do so and before you take note of any signals or results of this setup. 

As you will see from those results, this setup didn't win 100 percent of the time - none of my setups have - and it has the potential of costing me a decent chunk of change before my stop is hit.

Some other features of this setup:

- It has a wider range for the stop level than my other two setups for the S&P 500 and gold. That means my maximum position size has been adjusted down. It's also adjusted down even more because it was a little less robust on my confidence interval measures. I'm only risking a maximum of one percent of total assets on any single trade based on this signal - as opposed to two percent for the other two setups.

- Also note that one of the two signals that make up the crude setup is based on trading on the same side as the small traders. Normally, these folks are considered to be the dumb money in the markets, who are to be faded. I've found the data suggests that's not always the wisest course of action. The small traders tend to be trend-followers, who jump on trends rather than anticipate them. In the case of my small trader signal, it works by going long with an eight-week delay after the small traders hit an extreme net position in the markets. I can't presume to know why the signal works in such a robust way, but I figure it's because eight weeks is typically enough time for the trader exuberance to have exhausted itself, for a selloff to have taken place and run its course, and for markets to be ready for another upleg. 

- Note also that, like both of my other two setups, this one relies on two groups of traders. I've found pretty consistently that relying only on one group of traders is far inferior in providing reliable returns in backtesting. For example, relying only on the commercial signal of this setup would have resulted in a 43-percent loss in 2008. The small trader signal alone would have led to a 77-percent gain, but between 2003 and 2007 the gain would have just matched the market and the confidence interval for beating the market would have been a decent but unstellar 96 percent since 1995.

NOTE: This coming week's COT update will be delayed because I'll be on the road. I hope to get to it sometime over the course of the weekend. Apologies for the delay. Good luck this week.

TAGS: crude oil, 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 

Smart Money and Dumb Both Fading Rally

What a beautiful little rally we saw this week. Could it be? Could it be - dare I say it - a bottom? The major traders don't seem to know either. At least, not if we're to believe this week's Commitments of Traders data. This, of course, is the government data that reports on trillions of dollars in futures and options positions in major markets. 

This Friday afternoon's data shows the "dumb money" small traders in S&P 500 futures and options continuing their capitulation that started the week of March 17. Why, isn't that around when the broad markets really broke out and got this rally on solid ground? Oops! That, my friends, is why we call them the "dumb money." I don't mean to make light of the ill-fortune of the retail crowd, much less to denigrate these people. I am them! Most of us are. In most cases, they're really the victims of unscrupulous, poorly informed and downright criminal advisors, brokers, newsletter writers and a corrupt financial press.

These are the same folks who got highly bullish in November, just as the market cracked apart, and remained so until mid-March. Now, they're fading this rally. 

That has turned my signal based on fading these poor people bullish for the past two weeks. But that's n0t an all-clear by any means. I've found that trading on the basis of only one group of traders in the COT reports can often catch me in a bad trade. This is why I rely on two groups of traders giving an agreeing signal before I put on a position. Until then, I stay in cash.

And in fact, that's what my SPX setup says to do starting on next week's open. As you'll recall from my posts of the last two weeks, the "smart money" commercial traders are heavily shorting this rally, and it doesn't pay to bet against these guys. Today, they've reduced their bearish positioning from the previous week, but they remain super dubious. They're up to 1.56 standard deviations below the moving average I use for their signal, an improvement from 2.28 standard deviations below last week. So my SPX setup will stay in cash until these two groups of traders make up their minds. Stay tuned.

In gold, the large speculators, whom I fade in that market, have reduced their net long positioning as a percentage of the total open interest - down to 0.52 standard deviations above the average, from 1.12 standard deviations above last week. That signal remains bullish - same as it's been since last August. The reduction in their net long positioning is a good sign for gold bulls, as it means the froth is coming off this market.

Perhaps things will align right for a bullish bullion position two weeks out. My other signal in this market - based on fading the large spec total open interest - has flipped to bullish after one week being bearish. That's based on the "dumb money" large specs pulling out of the market and their total open interest (long plus short positions) flipping to 0.76 standard deviations below the moving average, down from 0.69 standard deviations above the average the previous week.

Have a happy Easter and see you here early next week with some news about a new trading setup for crude oil, which I've almost finished testing.

TAGS: S&P 500, SPX, gold, crude oil, 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 

"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