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