Thursday, 4 February 2010

Market Tanks! Was the Smart Money Wrong?

The market is caving in today, and that prompted a trader friend to express frustration about the commercial hedgers in the Commitments of Traders data. You'll recall from my post last Friday that they got uber-bullish last week. So what gives? Are they wrong? He also noted that commercials used to have a better record a few years back.

It made me wonder if there were types of markets when the correlation has worked differently. So I checked out the numbers. Check these correlations out. Overall, contrary to conventional wisdom, the "smart money" commercial trader net position as a percentage of the total open interest has had a negative -25-percent correlation with S&P 500 weekly open prices a week later.

That's right - a negative correlation. So trading alongside the commercials week to week would have lost you piles of money. That actually makes sense, in a way. These guys accumulate positions as markets decline and vice versa. It's only when they hit extremes of positioning that I've found you can trade alongside them. And then, only if their signal happens to agree with that of another group of traders. That's why I use two signals in my own S&P 500 setup and only trade when both agree. And on top of that, the signal tends to work most reliably not right away - but with a delay of about three weeks on average.

Here's something else I found. Here are historic correlations in certain time periods between the commercial net position and S&P 500 prices a week later:

- March 1995-Nov. 1997: -71%
- Dec. 1997-Dec. 1999: +14%
- Dec. 1999-March 2003: 0%
- March 2003-June 2008: +34%
- March 2003-today: +53%
- June 2008-today: +63%
- March 1995-today: -25%

So clearly, the COT data has changed quite a bit over the various periods in how it interacts with market prices. Trading just off this information would have been a fairly random exercise. That's again why I think the data needs to be filtered with some more complex trading system. Good luck the rest of this week!


almost said...

On Feb 3 after the cash close and into the CSCO earnings I was listening to the squawk box/pit noise of the big es contract and commercial was selling all the way up. I enjoy your blog, thank you.

W said...

That doesn't explain the GLD signal, though. And it's even worse.

Alex Roslin said...

Hi W.,

That post was about a specific issue related to the S&P 500 COT data, not wrong signals in general or the gold COT data.

My setup for gold isn't based on the commercial traders at all, so that's a different issue. As for why the signal so far isn't making money, check my FAQ page where I go into the issue of wrong signals in great detail.