Caution Ahead: Data

Oh-oh. Potentially bearish tidings in this week's Commitments of Traders report. The wrong-way small traders in S&P 500 futures and options are suddenly becoming a good deal less skeptical about the market rally. Meanwhile, as you can see on my newly updated latest signals table, the commercial hedgers - the so-called "smart money" - are a lot less bullish than they were last week.

This by itself doesn't mean a whole heck of a lot. The changes aren't anywhere near enough to flip my trading setup for the S&P 500 - which has been bullish since Aug. 24 - to cash or bearish. As well, the correlations between this data and next-week S&P 500 prices are so small it's hard to base decisions on them. (In fact, the small trader net position as a percentage of the total open interest has a slightly positive, albeit tiny 0.18 correlation with next week's S&P 500. Meanwhile, the commercials have a negative -0.27 correlation. So much for the popular wisdom that we should trade alongside the commercials or fade the small traders based on their weekly COT position changes. Doh!)

What is more interesting, however, is what's going on in the three-month Eurodollar contract. (That's the interest rate, not the currency.) This widely watched measure of global liquidity is putting up a caution flag. The large speculator total open interest has suddenly taken a nosedive. That's important because this indicator has a strong 0.61 correlation with next week's U.S BKX Bank Index. My setup based on the Eurodollar data remains in cash for the eighth consecutive week. It takes a position only when three different groups of traders agree in their positioning, which hasn't occurred. But this change in the data could spell more turbulence for the coming week.

Also, my setup for natural gas will go bearish with a one-week delay - i.e. on the open of trading the week of Oct. 5. That signal will not last long, however. One of the components of that setup - a signal that trades alongside the small trader total open interest - has gone bullish this week. That component, however, trades with a two-week delay, so it doesn't impact the coming signal for Oct. 5. It's just to say that the setup won't remain bearish for long and will go to cash or bullish after a single week of being bearish. Interestingly, both components of this setup have strong correlations of nearly 0.60 with the price of natural gas the following week. Yet, the two groups of traders are giving very conflicting reads of the market in the latest COT report. That, again, shows the importance of relying on more than one group of traders when attempting to interpret this data.

Hope you did okay this week and that you have a great weekend. Tune back in early next week for my portfolio update. And please keep your comments coming about the CFTC's proposed changes to the COT report. Read my post for more details ("Save the COT Report!") and a comment sent in by researchers in the Netherlands (scroll down to the end of this post).

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