Have the Commercial Hedgers Lost Their Mojo?

Have the commercial hedgers lost their smarts? It's a question one reader just raised in the comments to this post. The reader noted that the commercial traders' switch to a significantly more bullish stance in S&P 500 futures and options last week (as noted in my post of last Friday) isn't being reflected in markets so far this week. Since March, in fact, the commercials have been highly bearish on the markets, even as equities bounced upward sharply. So has the smart money lost its edge?

Firstly, one or two missed trades are nothing unusual in any trading strategy. Even the best traders typically have a 60-percent win ratio. So I think it's far too early to write the commercials off based only on a couple of days of a single signal. I've found the most robust signals based on the Commitments of Traders data typically last three or four weeks on average.

Secondly, I just did a little study and found that relying on the commercial traders in the S&P 500 the week immediately following big shifts in their positioning isn't a very useful strategy, either. My trading setup for this market works with a three-week delay for the commercial traders. Making your move on the open of trading the Monday following big shifts in the commercial net derivatives positioning would have gained 38 percent in 2008 - not bad, considering how the market tanked! - but during the 2003-07 bull, such a strategy would have gained less than half the return of the market.

Far more importantly, to my mind, even those gains would have occurred in a highly unreliable fashion. My backtesting shows a volatility-adjusted out-of-sample efficiency of just 48 percent for the compound annual return since 1995. That's a completely untradable score. It means the out-of-sample period scored just 48 percent of the in-sample backtested period. You want to see 70 percent or higher for the setup to have a chance of being reliable in real life.

But add a three-week delay before executing signals and the out-of-sample efficiency jumps to 120 percent. And throw in a second signal based on fading the small traders, again with a three-week delay, and that score jumps to 200 percent. As it happens, the small traders were already giving me a bullish signal for the S&P 500. So my own bullish signal for this setup takes effect on the open of July 20. Until then, that setup remains in cash.

Incidentally, out-of-sample testing is just one of many measures of robustness I think you've got to use in backtesting. (See my backtesting results table for some additional ones I use.) But it gives you an idea of how much of the common wisdom out there of how to use the COT data is based on little more than eyeballing some very complex data - not any actual real research. Good luck the rest of this week.

Rally Has Shaky Foundation

New U.S. house-price data is out. Looks pretty horrifying to me. People are talking up the slowdown in the rate of decline or even a turnaround.

But take a look at these charts from the S&P/Case-Shiller folks. The first one shows something like a rate-of-change indicator familiar to technical analysts. As anyone knows who studies this kind of thing, this type of indicator can stay oversold or overbought for a long time before price changes course. As well, an upturn or downturn in this indicator often doesn't register in prices for a long time, either.

The more important chart is the second one, on the next page - showing the actual house prices. No trend change there. Still down. About 33 percent since 2006.

And still more important, to my mind, is that even when the price decline meaningfully slows, that still means massive amounts of banks' leveraged assets continuing to lose value. Until house prices actually start rising, that is. I think this rally ends in tears in a big way when that starts sinking in. Yikes!

Smart Money Traders Turn Bullish on S&P 500

No new signals for this coming week from any of my trading setups based on the weekly derivatives data in the Commitments of Traders reports. But a big change in the data today signals a possible shift to a more bullish future. Or maybe just a one-week blip. Who knows? I've just updated my latest signals table based on this afternoon's new data.

Especially interesting: the "smart money" commercial hedgers have finally gotten off the couch and jumped into the S&P 500. If you're a regular here, you'll know the commercial traders haven't been exactly enamoured by the rally since March and have faded it with a large net short position in futures and options.

This week, big change. The commercials reduced their net short position significantly, triggering a bullish signal from their side in my S&P 500 setup. They haven't been this optimistic about the market since mid-March.

Note, however, my commercial signal works with a three-week trade delay. So no action until the open of trading Monday, July 20.

Another caveat: the other signal that makes up that setup - fading the small traders, who tend to be wrongly positioned at market turns - has moved closer to flipping from bullish to bearish. That's because, as you'll note on my latest signals table, these wrong-way folks have suddenly bumped up their net long position as a percentage of the total open interest. These people tend to be so wrong, in fact, backtesting suggests you could have reliably done the opposite and made good money.

So if they hit a bullish extreme in their positioning in coming weeks, that would put their signal in the bearish column. They're still not quite there yet, so things look good for the bullish side for now. Regardless, the S&P 500 setup will go bullish July 20, for at least one week.

Tune back in here early next week for a more detailed look at the other markets I'm covering with my setups and for a portfolio results update. Have a fine weekend.

TAGS: SPX, S&P 500, gold, BKX, Bank Index, Nikkei, crude oil, Treasury, bond, 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

Possible Green Shoots Amid Mixed Signals

Is this the big, long-awaited market selloff that will take us to retest the March lows? And possibly lower? Lots of skepticism abounds.

The picture from the latest Commitments of Traders data is fairly mixed, but there is some evidence for the bullish case. Still, as you'll see on my latest signals table, all my setups are in cash, except the one for Japan's Nikkei Average, which is bullish.

Below are some highlights from last Friday's data update. Be sure to check out my newly updated backtesting results table with the details for my two new setups for natural gas and the 30-year Treasury.

Also visit my portfolio page, which includes new trades as of this week's open. My tally from 10 real-time trades since last December based on my newly revised COTs Timer system is:

- seven wins, three losses; average return: 8.95 percent; average holding period: 2.88 weeks

- cumulative portfolio return: 23.6 percent (adjusted for the setups' maximum portfolio allocations)

And now for those highlights:

- S&P 500: The "smart money" commercial hedgers are finally buying into the rally, four months in. They've started to significantly reduce their net short positioning in S&P 500 futures and options and now stand just a hair below the line that would take their signal bullish for my setup.

The wrong-way small traders have been already on a bullish signal for seven weeks, owing to their excessively bearish posturing starting in early May.

- BKX U.S. Bank Index: Somewhat muddying the picture is the positioning in the three-month Eurodollar contract, a key liquidity measure. This data gives me signals for U.S. financials. As you can see from my latest signals table, the data has suddenly reversed course and gotten substantially more bearish, almost triggering a bearish signal for this market.

- 30-Year U.S. Treasury: After a two-week bearish signal (meaning the setup expected the Treasury yield to rise), this new setup of mine will go to cash on next Monday's open. That's because the small traders - whom my setup fades - hit a bearish extreme in their derivatives positioning last week, flipping their signal to bullish.

The other signal in this setup - based on fading the large speculators - has been bearish for six weeks. That's based on highly bullish positioning by the wrong-way large spec crowd. But the large specs have steadily reduced their total open interest relative to recent data and may be on track to reverse course soon.

- Crude Oil: My crude oil setup will remain in limbo for the foreseeable future due to conflicting advice from the commercial hedgers and small traders. Can't we learn to get along?

The commercials, who are normally right, have been bearish for five weeks. Their signal operates with a four-week trade delay for executing new signals. So that means bearishness from their corner for at least the next month.

Meanwhile, the small traders, who are also right in this market, just on a different timeframe, are super-bullish. Figure that one out. They've been on a bullish signal, in fact, since early December. And they now show zero signs of capitulation, with a highly bullish posture in their derivatives portfolio, as you'll see on my latest signals table.

Good luck the rest of this week, and for Quebec readers, Joyeuse St-Jean!

TAGS: SPX, S&P 500, gold, BKX, Bank Index, Nikkei, crude oil, Treasury, bond, 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

Depressing

That was some hard slogging action this week, wasn't it? If it's not a depression, it sure as hell is depressing. Derivatives data from the government doesn't show things getting much better, either.

As you'll see on my updated latest signals table, some of the latest numbers are a definite downer. My setup for the BKX U.S. Bank Index is showing signs of rolling over into bearish territory. Also, all my other setups have gone to cash - except for one, Japan's Nikkei Average.

You'll also see on my newly updated table that I've got a brand new setup: the 30-year U.S. Treasury bond. That one is presently bearish (meaning it expected yields, which move opposite to the bond price, to rise). But it's going to cash on the open of June 22.

Tune back in early next week for my portfolio update, a more extensive analysis of the latest data and an update to my backtesting results table with the details of my new natural gas and Treasury setups. Sorry I missed writing something up this past week! Have a good weekend and a nice Father's Day.

TAGS: SPX, S&P 500, gold, BKX, Bank Index, Nikkei, crude oil, Treasury, bond, 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

Gold Gone

I got stopped out of my long gold bullion position earlier this morning. I've updated my portfolio page with the result from that trade (a 12.0-percent loss) and with two other trades I executed on this morning's open - closing out my BKX U.S. Bank Index long position (a 19.7-percent gain) and going long natural gas.

Including the two trades today, I'm averaging an 8.7-percent gain with an average holding period of 3.1 weeks in my closed trades since I started to trade my revised COTs Timer setups last December. There were six gains and two losses in all. Good luck this week.

Pause for Banks, Natural Gas is Bullish

Some interesting new signals based on this afternoon's Commitments of Traders data. I've just updated my latest signals table with the calls from my trading setups based on this interesting weekly data on derivatives positioning in various markets.

New signals: cash for my BKX U.S. Bank Index setup after three weeks bullish; and bullish for my brand new natural gas setup. The latter had been in cash for 10 weeks. It's the setup's first bullish signal since last Sept. 2008, since which time it's been either bearish or in cash.

I'll update my backtesting results table with details from that setup next week. I'll also write a fuller update for all the setups early next week. Hope you fared well this week and best wishes for a great weekend.

TAGS: SPX, S&P 500, gold, BKX, Bank Index, Nikkei, crude oil, natural gas, 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

Nikkei Joins Banks, Crude and Bullion in Buy Column

Banks, crude oil and gold are still a buy. And now, so is Japan's Nikkei Average. That's the latest word from my trading system built around the derivatives data found in the weekly Commitments of Traders reports issued by the U.S. Commodity Futures Trading Commission.

I've just updated my latest signals table based on this afternoon's latest COT report. Check out those signals and the new numbers here. Here's more on how the markets are shaking based on this nifty data:

- S&P 500: The "smart money" commercial traders are still non-believers when it comes to the market rally - as they've been since the end of March. The recent market pause has seen them slightly reduce their large net short position in the past two weeks.

But as you'll see from the numbers on my latest signals table, they're still decidedly bearish in their futures and options positioning. And they've got a long way to go before their signal turns bullish. My SP500 setup is in cash a second week in a row and will remain so for at least the next three weeks.

- Banks: My setup for the BKX U.S. Bank Index - a basket of the major financial players - is bullish a third week in a row. If the SP500 setup is ambivalent, this one is real bullish. One possible warning sign: the large speculator total open interest has fallen fairly sharply this week. That's potentially bearish.

On the other hand, the small trader total open interest - which my setup trades alongside - has shot up to one of the most bullish levels in the entire history of this data. The small traders haven't been this bullish in comparison with recent data since the end of Jan. 2005. That was when BKX started a major breakout after a year-long trading range - and ultimately the beginning of a two-year bull run.

- Nikkei: My setup for Japan's Nikkei Average goes bullish for next Monday's open. It will remain bullish for the next eight weeks at least. (Beyond that, can't say. The powers of this setup go only so far!)

- Crude oil: This setup will remain bullish for two more weeks, then go to cash for three weeks. That move to cash is because of disagreement between the two signals that make up the setup and the time lags they use before a trade is executed. The commercial traders got historically bearish three weeks ago in their crude futures and options positioning - hitting an astonishing 2.51 standard deviations below the moving average. Bad sign! So the overall setup will go to cash on the open of June 22.

- Gold: Two more weeks for my long position in bullion. The wrong-way large speculators have once again this week increased their net long positioning in gold futures and options. That's four weeks of increasing bullishness in a row. Still, they now stand at a middling 1.39 standard deviations above the average - well short of the 1.9 standard deviations needed to flip their signal to bearish.

But my other signal making up this setup - based on the large spec total open interest - has been bearish for six weeks now. It works with a seven-week trade delay, so it has yet to take effect. But it will do so the week of June 22, when this setup will either go to cash or bearish - depending on what the first signal (based on the large spec net position) does. Stay tuned. So far, so good.

Overall, I've been pretty happy with how my newly revamped setups are performing this year. I'm hoping to create a new table somewhere on the site to keep track of my real-time trading results. I'm also working on a new setup for natural gas, which I hope to finish up next week. Thanks for tuning in, and I hope you fared well this week. Be sure to check in early next week when I update my portfolio page. Have a good weekend.

TAGS: SPX, S&P 500, gold, BKX, Bank Index, Nikkei, 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