Tweaked S&P 500 Setup Bearish

Spent the weekend taking another look-see at my trading setups based on the Commitments of Traders data. I wanted to apply a few new optimization techniques to the existing setups made easier by some additional automation I've added to my Excel spreadsheets. The results are on the latest signals table. I've made slight adjustments to each of my three setups for the S&P 500, gold and crude oil. The backtested returns are a little weaker, but the key measures of robustness I'm looking at (see the far right hand part of the table) are superior for these new setups. The current signals for gold and crude are the same as for the old setups, but my S&P 500 signal is now bearish for its second straight week. I've also just posted a new S&P 500 spreadsheet at my DIY guide page so you can take a look for yourself.

Gold Good to Go

What a bizarre close. As Stephen Vita has been noting at his AlchemyOfTrading site (a truncated free version of which is available here), the S&P 500 has come up again to resistance at a key DeMark Setup Trend line just below 870 and, near the close today, it bounced down abruptly from there. On the other hand, the HGX Housing Index has broken out nicely above TDST daily line around 90. Next week should be interesting. The Commitments of Traders data is equally ambivalent about equities and crude oil, but it's finally giving a new signal for my trading setup for gold. (See my latest signals table for the details based on this afternoon's weekly COT data release.) Here are some highlights based on today's report:

- Eleven weeks in cash are at an end for my gold setup. It's gone bullish with execution for the open of Monday's trading. I can't tell how long the signal will stay bullish, but things look good for now. The wrong-way large speculators are nowhere being excessively long, which is bullish. Their net position as a percentage of the total open interest actually fell this week to 0.34 standard deviations above the average I use for their signal, down from 0.62 standard deviations above last week. They need to hit 1.9 standard deviations above for that signal to go bearish - so all clear for now. This signal works with no trade delay - so it's the unknowable question mark when it comes to trying to see into the future of this market beyond the coming week.

The other signal that makes up my gold setup has a seven-week trade delay. It went bullish the week of March 3 and has been so ever since, with the exception of a single week (the week of March 31). This signal is based on fading the large spec total open interest (long plus short positions in futures and options). These guys' open interest level is comfortably bearish right now - 0.51 standard deviations below the average, up a little from 0.82 standard deviations below the prior week. So unless the large spec net long position suddenly explodes, we can probably expect a bullish signal lasting a few weeks at least. Of course, with today's markets, all guesses are worthless pretty much as soon as they're written down. So ignore what I said.

- Crude oil: My setup for crude is in cash for a single week starting Monday, then goes back to bullish for the open of trading the week of May 4. Small traders, who are the "smart money" in this market (believe it or not), have been bullish on crude since early December. The commercial traders, paradoxically also the smart money, have been a little more uncertain. But the week of March 31 they really got hot on crude futures and options, moving the commercials into the bullish column. Starting May 4, the setup will remain bullish for two weeks.

- S&P 500: The smart money commercial traders remain highly dubious about the market rally. Their net position as a percentage of the total open interest has fallen to 1.63 standard deviations below the average, down from 1.02 the previous week. Meanwhile, the small traders, whom I'm fading in this setup, are quite a bit more bullish than last week's paroxysm of gloom. They've come up to just 0.01 standard deviations below the average, up from 0.50 standard deviations below. Despite this, they remain pretty far from being excessively long, too. So they're still on a bullish signal, while the commercials remain with their bearish call. The setup overall is therefore in cash again, for a third week.

I should note that if I had placed a trade based just on the commercials bearishness, I'd be out of a good chunk of money. It's an example of something I've found pretty consistently in looking at this data: a signal based just on one group of traders is typically a lot less reliable than one using two or more traders, when they agree.

Hope you have a fabulous weekend, and hope to see you here next week with a portfolio update and a new trading setup for the BKX Bank Index, based on the three-month Eurodollar COT data.

TAGS: SPX, S&P 500, NASDAQ 100, gold, BKX, Bank Index, 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 

Apologies... Latest Signals

Apologies for my late post on last Friday's data. I just got back from a trip away and didn't have access to a computer. I've now updated my latest signals table, and as you can see there weren't any new signals from last week's data for my trading setups based on the Commitments of Traders reports. But that's not to say there weren't some interesting developments in the latest data. I'll post a more detailed look Wednesday and see you back here Friday with the word from my setups based on the next data release, including a new signal for my crude oil setup and possibly for gold bullion, too. Good luck the rest of this week!

Crude Data Warns of Volatility But Suggests More Upside

Crude oil might be due for a little more upside, but my new trading setup for black gold is also warning of possible volatility in coming weeks. I've just posted the latest signal information and backtesting results for this new setup on my latest signals table.  The setup beat the market hands-down during the bull and bear markets of 2003-08, with a compound annual return of 29.99 percent (including 0.2-percent trade friction per trade) while being in the market less than half the time - compared to a gain of 3.13 percent for crude. While crude crashed 57 percent in 2008, this setup gained nine percent through being short or in cash. 

Most recently, the setup has been bullish for the past four weeks - its first time being long since Oct. 2007. It will remain bullish one more week, then go to cash for a week and go back to long for two more weeks after that. The parameter details for the setup are all in the notes to the latest signals table. I haven't posted a spreadsheet for the setup, but might do so eventually. You can still create it for yourself using the values I've listed in those notes and plugging them into the S&P 500 spreadsheet I've posted on my DIY page. Please be careful to read all my disclaimer information before attempting to do so and before you take note of any signals or results of this setup. 

As you will see from those results, this setup didn't win 100 percent of the time - none of my setups have - and it has the potential of costing me a decent chunk of change before my stop is hit.

Some other features of this setup:

- It has a wider range for the stop level than my other two setups for the S&P 500 and gold. That means my maximum position size has been adjusted down. It's also adjusted down even more because it was a little less robust on my confidence interval measures. I'm only risking a maximum of one percent of total assets on any single trade based on this signal - as opposed to two percent for the other two setups.

- Also note that one of the two signals that make up the crude setup is based on trading on the same side as the small traders. Normally, these folks are considered to be the dumb money in the markets, who are to be faded. I've found the data suggests that's not always the wisest course of action. The small traders tend to be trend-followers, who jump on trends rather than anticipate them. In the case of my small trader signal, it works by going long with an eight-week delay after the small traders hit an extreme net position in the markets. I can't presume to know why the signal works in such a robust way, but I figure it's because eight weeks is typically enough time for the trader exuberance to have exhausted itself, for a selloff to have taken place and run its course, and for markets to be ready for another upleg. 

- Note also that, like both of my other two setups, this one relies on two groups of traders. I've found pretty consistently that relying only on one group of traders is far inferior in providing reliable returns in backtesting. For example, relying only on the commercial signal of this setup would have resulted in a 43-percent loss in 2008. The small trader signal alone would have led to a 77-percent gain, but between 2003 and 2007 the gain would have just matched the market and the confidence interval for beating the market would have been a decent but unstellar 96 percent since 1995.

NOTE: This coming week's COT update will be delayed because I'll be on the road. I hope to get to it sometime over the course of the weekend. Apologies for the delay. Good luck this week.

TAGS: 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 

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 

"Smart Money" Traders Betting Against Sucker Rally

An awful lot of people seem to think the worst is over for stocks. But a big time bomb may be close to detonating in the derivatives market. The "smart money" commercial traders - who are usually correctly positioned at key market junctures - have been massively fading the current stock rally.

Their net position last week in S&P 500 futures and options was 1.92 standard deviations below the moving average I use for my trading setup based on the Commitments of Traders data.

Friday's data saw them get even more net short. Their net position as a percentage of the total open interest fell to 2.28 standard deviations below the average. That's the most bearish they've been since early December - right before the market collapsed and took out its 2002 lows.

But the data isn't entirely bearish and is giving some mixed signals. While the commercials have been running for the exits, the "dumb money" small traders have also gotten bearish. My trading setup needs to see both groups of traders give the same signal before I'll actually bet money on a trade. And the little guy got super-bearish last week, which actually resulted in a bullish signal for the S&P 500.

Then, on Friday, the small traders significantly increased their net long position. They went from 0.53 standard deviations below the average to even with the average on Friday. For my signal to flip to bearish, they need to hit 0.2 standard deviations above the average.

What does all this mean? Until the two signals agree, my setup for the S&P 500 will remain in cash.

This setup also has a three-week trade delay, and the two signals stopped agreeing with each other as of the March 17 COT report. So my setup goes from bearish to cash on the open Monday, April 13, and will remain so for the next three weeks, at least.

As for gold, the other market for which I've developed a COT trading setup, the signal remains in cash next week - its ninth in a row. But there's suddenly some bearish news looming over the horizon, after four weeks of potentially bullish posturing.

On Friday, the "dumb money" large speculators upped their total open interest by a sizable amount, bringing it to 0.69 standard deviations above the average, up from 0.55 standard deviations below the average the previous week. This sudden turn-around has caused my large spec open interest signal to go bearish, after four weeks in the bullish column. This signal works with a seven-week trade delay, so the flip-flopping signals don't have any bearing until the end of April.

What happens then depends on what the other signal that makes up my gold trading setup does. That other signal is based on fading the large spec net position as a percentage of the total open interest. (There is also no trade delay for this second signal - meaning the trade would be executed on the Monday after the signal.)

The large specs also seem to be on the move in their net positioning. Their position has gone from 0.74 standard deviations above the moving average to 1.12 standard deviations above. They haven't quite hit excessive territory yet, but they're getting closer. I guess the gold bugs are working overtime trying to get everyone piling in. So my signal based on fading the large spec net position remains bullish. But for the entire gold setup to go bullish at the end of April the large speculators have to put on the brakes. Or we could be in for continued volatility in bullion.

Hope you had a great weekend, and good luck this week!

TAGS: S&P 500, SPX, gold, 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

S&P 500 Commercials Fading Rally

Not sure what to make of this market. I think the Commitments of Traders data from this afternoon is equally ambivalent. Derivatives traders in S&P 500 futures and options have gone bipolar this week. You'll recall my S&P 500 trading setup has been bearish for a few weeks. 

Last week, the "smart money" commercial traders flipped from bearish to bullish as they dramatically reduced their net short position. The commercial signal works with a three-week trade delay, but things were looking bullish. At the same time, small traders, who've been highly bullish since November in their futures and options positioning, had suddenly reduced their net long positioning last week. 

Well, things have changed. Today's data has caused both of my signals to flip. 

The commercial traders have suddenly ramped up their net short position again as the market rallied this week. They're clearly fading this bounce. Their net position as a percentage of the total interest has gone from 1.48 standard deviations above the moving average I use for the commercials signal to 1.92 standard deviations below the average. Their signal has flipped back to bearish after one week in the bullish column.

Meamwhile, the "dumb money" small traders have gone ahead and continued their capitulation that started last week. They're now 0.53 standard deviations below the moving average I use for their signal - down from 0.63 standard deviations above the average. That's caused my small traders signal to flip to bullish as the wrong-way retail crowd has also decided to fade this rally. Amazing.

Both signals work with a three-week trade delay. So where things stand right now is this: the current bearish signal will continue this coming week and the next and then - because the two signals don't agree - the setup goes to cash on the open of trading Monday, April 13.

As I noted in a comment to my post Wednesday, my current bearish S&P 500 position got stopped out that day after it hit my 8.82-percent stop level. That level comes from taking the average backtested trade gain and subtracting two standard deviations of the trade returns. The idea is to end the trade if markets appear to be acting outside historic norms. The largest past drawdown for this setup is 19.05 percent. So far, the setup loss wouldn't have been anywhere near that. But if the S&P 5oo rises to 903.43 during the life of this bearish signal - equal to a 19.05-percent loss for a bearish position - I'll invoke my Black Swan risk-control rule. That means I'd halt trading this setup for four weeks. The idea is to avoid markets when they are acting completely outside the historic norms seen in the backtesting.

On the other hand, if the S&P 500 falls below my entry price when the signal started (758.84),  I'll enter another short position for the duration of this bearish signal.

The COT data for gold is a little less eventful of late. The setup is in cash, but seems primed to enter a trade on the bullish side at the end of April. My signal based on fading the large spec total open interest remains in its fourth week of being bullish. That signal works with a seven-week trade delay. So if the other signal within this setup remains bullish, I'll go long in a few weeks.

Hope you have a great weekend. I'll update my portfolio page early next week with my recently closed S&P 500 position.

TAGS: S&P 500, SPX, gold, 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

Tests of Short S&P 500 Stop Levels

Interesting couple of days. My two short positions for my bearish S&P 500 signal have come close to be stopped out each of the past three days. My stop levels are $72.73 for the 200-percent leveraged SDS ProShares Ultra Short S&P 500 ETF and $31.17 for the 200-percent leveraged HSD Horizons BetaPro Bear Plus S&P 500 ETF (trading in Toronto). Good luck for the rest of the week - and see you back here Friday.

Signs of Bottom? Wrong-Way Traders May Have Started Capitulation

Another nutty week! Completely fitting for the times. The Commitments of Traders data released this afternoon also has some interesting new things to say. I've now updated my latest signals table based on today's data. Some highlights:

- S&P 500: Some possibly important shifts appear to be taking root in the derivatives data for the SPX. They've caused my trading setup based on the COT reports to give a new signal - cash - to be executed with a three-week trade delay on the open of Monday, April 13. The "smart money" commercial traders have dramatically reduced their net short position as a percentage of the total open interest. Their positioning went from 0.84 standard deviations below the moving average I use for my commercials signal last week to 1.48 standard deviations above the average this week. That's flipped my commercial trader signal from bearish to bullish - with the three-week delay I mentioned earlier. The other signal that makes up this setup is based on fading the wrongway small traders - who tend to be badly positioned at market turns - when their positioning hits certain extremes. Last November, they hit a bullish extreme that put my signal for the small traders in the bearish camp. This week, they've finally broke down and got substantially less exuberant. It seems the market losses have finally sunk in. They've gone from 1.56 standard deviations above the average to 0.63 standard deviations above. Their positioning still has to fall further - down to 0.2 standard deviations above the average - in order for this signal to flip to bullish, but this week may have been an important break. They've haven't been anywhere near to this bearish since November. If we see more signs of capitulation soon, we could be close to a bottom - though whether it's an interim or longer-term bottom, I have no idea.

Gold: No change for my gold setup, which remains in its seventh straight week of being in cash as bullion meanders in what appears to be a long trading range. However, my large spec total interest signal is now in its third week of being bullish - based on fading the large speculator total long and short positioning. I trade their signal with a seven-week trade delay. The other signal within my gold setup - based on fading the large spec net positioning - has been bullish since last August. So if the two signals remain bullish a few more weeks, I expect to go long at the end of April.

Hope you have a rejuvenating weekend. I'll update my portfolio page early next week with my S&P 500 position results.

TAGS: S&P 500, SPX, gold, 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

S&P 500 Rally Could be Short-Lived

A nice little rally this week, but was that really the bottom? Reading some of the latest free reports this week and last from Montreal's BCA Research makes me doubt that it is. As well, the indices are still well below their Tom DeMark Setup Trend lines on the daily charts. The monthly charts are even worse, especially for the Nikkei, S&P 500 and Dow. And what about the Commitments of Traders data? Some of the latest data from today's release doesn't give any fresh hope for a real recovery, in my opinion. I've updated my latest signals table with the calls from my trading setups based on this data.

- S&P 500: The small traders are still far too bullish, as they've been since November during the entire decline. This is a bad sign, if historic trends are any indication. Friday's data shows their net position falling ever so slightly from 1.60 to 1.56 standard deviations above the moving average as a percentage of the total open interest. The "smart money" commercial traders are still deeply bearish, though a tad less so than last week, with their net position going from 1.02 to 0.84 standard deviations below the moving average. I had a bearish signal from this trading setup from three weeks ago that takes effect on the open of trading this coming Monday, March 16. The latest bearish reading of the data means the setup will remain in bearish mode for at least the next three weeks.

- Gold: This setup remains in cash another week - the sixth straight week. But a bullish sign is that the large speculator total open interest has fallen again. It's now 1.21 standard deviations below the moving average I use for this setup, down from 0.72 standard deviations below. This signal has been bullish for two weeks in a row now, but it works with a seven-week trade delay. The other signal that makes up this combo setup - based on fading the large spec net position - is already bullish. So the setup could go from cash to bullish in six weeks' time if the large spec net position signal is bullish at that time.

Hope you have a relaxing weekend. I'll update my portfolio page early next week with the bearish S&P 500 position.

TAGS: S&P 500, SPX, gold, 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

S&P 500 May Pause Before Next Leg Down: Data

Wow. What an absolute disaster of a week. The Dow and S&P 500 are now well below their 2002 lows. The Nikkei has decisively broken below its 2003 low. The FTSE is now testing its lows of the last bear market. But Canada's TSX index is, oddly, well above its 2002 bottom. Does that mean there is still some hope for the market, with Canada's outperformance representing resilient commodity demand? Maybe the commodity bull really isn't over and is just seeing one hell of a huge correction? I don't know. What I can say is Friday's Commitments of Traders report doesn't give much hope for equity bulls. I've now updated my latest signals table. Some highlights from the latest weekly data:

- S&P 500: My trading setup for the S&P 500 has been bearish since November, but this coming week it goes briefly to cash. That's based on the commercial trader net futures and options positioning during the week of Feb. 10, when it abruptly rose to a bullish extreme. It quickly fell back into bearish territory the following week, so my setup goes back to bearish on the open of Monday, March 16, and will remain so for at least the ensuing three weeks. In the latest COT report, the commercial net position as a percentage of the total open interest dropped from 0.47 to 1.02 standard deviations below the moving average I use to evaluate their positioning. Meanwhile, the "dumb money" small traders - far from turning more bearish during the latest market cataclysms - have actually become even more bullish. Amazing! In Friday's data, their net percentage-of-open-interest position went from 1.48 to 1.60 standard deviations above the average. Not good at all if you happen to be a bull. They obviously are convinced the bottom is in. But their poor past record raises questions about whether that's the case.

- Gold: My trading setup for gold based on the COT data remains in cash again this week - the fifth in a row. The two signals that make up this setup don't agree with each other again. However, some possible light at the end of the tunnel: my signal based on the large speculator total open interest (long plus short positions) has flipped to bullish. That signal has a seven-week trade delay - which means the overall setup can't go to bullish for seven more weeks. Until now, the large spec total open interest has been persistently excessively bullish during the recent gold rally. That turned the setup to cash after a three-week bullish call. Now, the large specs have suddenly pulled back from being 1.07 standard deviations above the moving average to 0.72 standard deviations below. If my other signal - based on fading the large spec net percentage-of-open-interest position, but with no trade delay - is bullish in seven weeks' time, I'll be shopping for some bullion.

Hope you have a good weekend. And be sure to check out the updated post on my portfolio page early next week.

TAGS: S&P 500, SPX, gold, 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