Friday 30 May 2008

NASDAQ 100 to Cash, Going Long Gold Monday

Quiet week this time around from the Commitments of Traders data. That's the nifty weekly info on trader positioning in all the major markets released by the kind folks at the U.S. Commodity Futures Trading Commission. Here's what they told us this week:

- Commercial traders in NASDAQ 100 futures and options have been dumping their net long positions steadily for six weeks. The "smart money" folks have just hit a bearish extreme low in that positioning that has given me a sell signal in my setup for these traders. My overall NASDAQ 100 setup, however, relies on acting only when my commercial and large speculators setups both agree in their signal. The large specs happen to still be on a long signal, so that means I'm going to cash in this market on Monday's open of trading, June 2.

- My gold trading setup flipped to bullish with the May 13 COTs report, so with that setup's two-week trade delay, execution is for Monday, June 2. A quick check of the other markets that are highly correlated to gold (that would be silver, platinum, copper, heating oil and crude) shows that two are presently bearish (silver and copper) while the remaining three are bullish. That means I can take this gold signal on Monday as a majority of the highly correlated markets will be in the bullish column on that day.

You can see the rest of the updated signals from my setups based on this interesting government data at my Latest Signals page (click the first table link). Have a great weekend and good luck next week!

Tuesday 27 May 2008

New: See Trade Returns on My Updated Portfolio Page

I've just updated my Portfolio page with returns from each ongoing and recently closed trade. I think they'll be quite interesting to track. I've also updated that page with my trades as of this week's open of trading - selling my long base metals position and U.S. banks short position, and going long U.S. banks and the Russell 2000. I talked about the signals behind those trades in this post Friday. Incidentally, I think that portfolio table also shows something important about trading: even when some trades have extreme profits, there are always others that lose some money. Drawdowns are something that paralyze a lot of traders and investors, leaving them in a muddle about how to react. They highlight what I think is one of the most vital aspects of trading: risk management through pre-defined stops and proper position sizing to fit your own personality and account size. With those elements in place, I think you can trade much more confidently and, with luck, more profitably. See more on my own risk-control systems here (scroll down to "Portfolio Allocation" and "Stop"). Good luck this week.

Friday 23 May 2008

Equities, Crude Rallies Not Over: Data

Is crude oil peaking? Are stocks in a bear rally that's poised to end? Not according to this afternoon's Commitments of Traders data. Trader positioning is giving me few bearish indications, at least if past patterns are any indication. (Of course, they often aren't!) I've just posted the latest info from my trading setups based on this data on my Latest Signals page.

Some highlights:

- My setup for the Russell 2000 has just flipped to bullish. That puts all five of my equities trading setups in the bullish column, since my setup for the BKX Bank Index is also calling for a long trade to be executed for the open of next week's trading.

The Russell 2000 setup is based on trading on the same side as the "smart money" commercial traders when their futures and options net position hits specific extreme points as a percentage of the total open interest. Their net position has actually gotten steadily more bearish since hitting a high point in mid-April, but it's more or less flattened out in today's data release. More importantly, it's gotten less extremely bearish in comparison to the moving average I use for that setup.

- My setup for crude oil remains steadfastly bullish, at least for now. This, despite the fact that my setup for heating oil, a market that's very highly correlated with crude, flipped to bearish with the May 6 COTs report (for execution June 23 because of the setup's six-week trade delay). But take a look at some of the figures I've posted on the statistical robustness of the two setups. (See the table on the Latest Signals page.) The confidence intervals for the crude setup are significantly higher than those for heating oil. These and other measures for robustness I use lead me to think the crude setup has a higher chance of being right. So the crude blow-off could have more room to blow off. Oh-oh. At least, any profit on that trade would help me fill my gas tank!

- Data on U.S. dollar index futures and options shows the "smart money" commercial traders getting steadily more bearish since an intermediate peak in mid-April.

- My setup for copper is saying to go short on next week's open of trading. This is based on a bearish signal back in March that takes effect only now because the setup uses an eight-week trade delay. This signal will mean that three of my six highly correlated commodities setups will be bearish Monday (gold, silver and copper) while three remain bullish (platinum, crude oil and heating oil). This means that even though I will sell my long base metals position based on the previous long copper signal, I won't go short. That's because of my new risk-control rule for trading highly correlated markets. See more on that here. So far, I'm really liking this new rule. It's kept me out of some trades that would have resulted in pain, while giving me more confidence when I do take a trade. That said, full testing on a portfolio scale is important for the rule, and that's on my to-do list. Hope you have a great weekend, and good luck next week!

Friday 16 May 2008

Banks, Bullion Back to Bullish

A couple of interesting new signals from my trading setups based on this afternoon's update on trader positioning from the U.S. Commodity Futures Trading Commission. After being profitably short the banks since May 5, my setup for the BKX Bank Index has now flipped back to bullish. This setup is based on trading on the same side as the large speculators in the three-month Eurodollars. (That's the interest rates, not the currency; it's basically a play based on global liquidity.) The setup is one of my favourites to trade and works with a one-week trade delay, which means I'm dumping my short position and going long on the open of Monday, May 26.

The other major new signal comes from my gold setup: bullish. This one also trades on the same side as the large speculators. (They're not always the dumb money, contrary to what many analysts say about these guys.) The setup works with a two-week delay, meaning I'll go long on the open of trading Monday, June 2. I should mention that this setup recently gave a bearish signal, which is supposed to be executed for the open of trading next week. I'm going to be sitting this one out due to my new risk-control rule. You can read more about that rule in this blog post and on my "How It Works" page. The bottom line of it is this: gold is highly correlated with five other commodities markets. Of those, four are presently on bullish signals. That means I ignore the gold bearish signal but would of course take the long gold signal on June 2, provided the majority of those six highly correlated markets is still bullish at that time.

A final note: commercial traders in U.S. dollar index futures, upon whom my setup for the greenback is based, have just flipped to a net short position as a percentage of the total open interest. This by itself isn't that relevant, but the "smart money" in this market also happens to be more short now in absolute terms than any time since Feb. 2007, just before the buck broke down from a long sideways range. The positioning is also more bearish now in relation to historical positioning than any time since early January 2008, just before the dollar saw its latest slide. My setup for the U.S. dollar has actually been bearish since Oct. 2006, so this doesn't change anything for that setup. But I think it's of interest in light of questions about whether the recent commodities rally is on its last legs. The data suggests a good chance it's not. Have a great weekend, especially to Canadians with Monday's holiday, and good luck next week.

Tuesday 13 May 2008

Highly Correlated Markets: New Rule Explained

I thought I'd give a little more explanation for a new rule I adopted a couple of weeks ago on how to manage signals in highly correlated markets when they contradict each other. What to do when my silver setup goes short while gold remains long? Am I betting against myself by taking both signals? I've ordinarily traded all such signals without hesitation and ultimately think that's the best way to take advantage of the full potential for each setup. As Curtis Faith pointed out in his classic Way of the Turtle, you never know which signal will be the one that lifts your portfolio into orbit, so you must follow each trade with discipline.

But as I'm still refining my system, I wanted to temporarily adopt a risk-control rule for these situations. The rule works like this: If I get a signal from a setup, I check what my other setups are doing in markets that are highly correlated. If the majority of signals agrees, I take the trade. If not, I ignore the signal. For example, if my BKX Bank Index setup says to go long for Monday, May 19, I check my setups for the two markets that are highly correlated to BKX - the Dow Jones industrials and Russell 2000. I take the BKX trade if at least one of those is also bullish or will be bullish as of May 19.

Below you'll find a table of highly correlated markets. I defined markets as "highly correlated" when their weekly open prices have greater than 0.85 correlation between March 1995 (the start of the combined futures and options Commitments of Traders data) and the end of 2007 (the end of my test data). This new rule is somewhat of a work in progress and will no doubt evolve as I continue to refine my setups. On that score, I've been getting promising results from out-of-sample testing for my setups and revisiting my setups in order to account for trading friction (i.e., commissions) and recent performance during the bull market. I'm also getting some great results from examining new setups based on combining the signals from two trader groups or two different parameter values for the same trader group. Stay tuned.

Highly Correlated Markets Table

S&P 500:
Dow Jones industrials
Dow Jones industrials: BKX Banks Index and Russell 2000
Russell 2000: BKX Banks Index and Dow Jones industrials
NASDAQ 100: n/a
BKX Bank Index: Dow Jones industrials and Russell 2000
Nikkei: n/a
Natural gas: n/a
Gold, copper, silver, platinum, heating oil, crude oil (all highly correlated with each other)

1) Markets like the Nikkei and NASDAQ 100 that have the notation "n/a" aren't highly correlated with any other market. Incidentally, I think these uncorrelated markets are great for building diversity into my portfolio.
2) No trade will be taken in the case of an equal number of long and short setups in highly correlated markets.

Friday 9 May 2008

Ill Omen for Energy Sector as Heating Oil Goes Bearish

Quietish week this time around in the trader positioning as reported in this afternoon's Commitments of Traders report. See how it all went down on my Latest Signals page. Some highlights:

- Heating oil has flipped to bearish. This trading setup is based on the large speculative funds, which have sharply reduced their net long futures and options position as a percentage of the total open interest. Heating oil is almost perfectly correlated with crude oil, so this could be a portent of things to come in the wider energy complex. The heating oil setup works with a six-week trade delay, which means execution of the trade would be for the open of trading on June 23.

- My crude oil setup is still long, but it works with a shorter four-week delay, so there's still time for it to go bearish in the same timeframe. Recall that we're getting close to the end of the yearly favourable seasonal energy play.

- My Canadian dollar setup, also highly correlated with crude oil, is giving a wobbly set of signals for the coming few weeks as trader positioning suggests a bearish patch. Have a great weekend, and good luck next week!

Monday 5 May 2008

Oops! Corrected Signal

I was just rechecking some of my spreadsheets and noticed a mistake on my Latest Signals table based on Friday's Commitments of Traders data. My gold stocks setup (for the HUI Gold Bugs Index and XGD Canadian Gold iShares) didn't actually flip to bearish as I had reported Friday. It remains long as it's been since May 2007. My gold and silver setups did, however, indeed go bearish as reported. I've corrected that table accordingly. Many apologies for the mistake!


Just updated my portfolio page with trades from this morning's open. I sold my gold, silver, Russell 2000 and financials positions and picked up 200-percent leveraged ETFs to go long the NASDAQ 100 and short the banks. Good luck this week!

Friday 2 May 2008

Sells for Bullion, Banks and Russell 2000

Okay, that's just nuts. I think this afternoon's Commitments of Traders data on positioning in the major markets has set a record for most new signals and wildly swinging holdings. The data is saying the market is steaming into some kind of Drake Passage of turbulence. Check out the table linked on my Latest Signals page for all the gory details. Some highlights:

- My trading setups for gold, the HUI Gold Bugs Index/XGD Canadian Gold iShares and silver have all flipped to bearish. The gold setup uses a two-week trade delay, meaning execution is for the open of trading May 19, while the other setups have no trade delay, which means execution is for Monday's open.

- My NASDAQ 100 trading setup has flipped to bullish after the commercial traders increased their net long futures and options position.

- As well, my trading setup for the Dow Jones Industrial Average, which has been bearish since late January, has flipped to bullish. The DJIA setup fades the "dumb money" large speculators, who have suddenly gotten quite nervous and reduced their net long position to a specific point that in the past has signaled a good trading opportunity. From our contrarian point of view, their bearishness actually tends to be a bullish development.

- However, my Russell 2000 setup feels quite differently about things these days. This setup is based on trading on the same side as the commercial traders, and it just flipped to bearish. As well, my setup for the BKX Bank Index, based on the three-month Eurodollars contract, has flipped to bearish for execution on Monday's open of trading.

- What to do about all these contradictory signals? I've thought about this and come up with some new rules I'm going to try out for this kind of situation. It often happens that data from two closely related markets contradicts each other, and I have a hard time stomaching putting on long and short trades at the same time in such cases. What I did was study the correlations of various markets (I'll post the table soon) and out of that emerged this rule: trade signals only when a majority of the setups in highly correlated markets are positioned in the same direction, whether long or short.

So in this case, I found the NASDAQ 100 isn't highly correlated with any of the other equity markets. This means I'm going to act on that signal regardless of what the other markets do. However, DJIA, RUT and BKX are all highly correlated (which I defined as over 85 percent correlation). Of those three markets, two will be bearish as of Monday's open of trading (BKX and RUT), while one will be bullish (DJIA). So this means I short BKX and RUT and ignore the new DJIA signal. Incidentally, the S&P 500 is only highly correlated with the DJIA under my definition. Under my new rule, I shouldn't have a trade on for that setup or DJIA because the opposing signals simply cancel each other out.

The other major group of highly correlated markets consists of gold, silver, platinum, copper and crude oil. As of Monday, two of these five will be bearish, so the majority will still be bullish. That means I'll maintain my long copper and crude positions and avoid going short gold or silver.

I'll test out this new system for a while and see if it needs refinements. Your input of course is welcome. I also recognize I still need to do some actual number-crunching to see the impacts of this rule on the statistical robustness of the setups. Have a good weekend.

Thursday 1 May 2008

Shorting Treasuries Made Easier

ProShares has just launched two leveraged inverse Treasuries ETFs. Tickers: PST and TBT. Read more about it here.