Banks, Energy, Nikkei Could Bounce

Looks like some major breakdowns in the markets this past week. Seems almost predestined that we're headed for a retest of the March lows - and maybe lower. But behold the news from Friday afternoon's Commitments of Traders report. It's actually quite bullish on some fronts. Crude oil and gold still look under pressure for now, but the banks, natural gas and, to some extent, the S&P 500 data are looking up. And in crude, my trading setup has turned bullish for mid-August.

Here are a few highlights from the data that I've just updated on my latest signals table.

- S&P 500: The "smart money" commercial hedgers have shot up to 2.43 standard deviations above the moving average in their net futures and options positioning as a portion of the total open interest. They haven't been this bullish compared to the past data since the end of Sept. 2007. The latest COT report shows them at their 12th most bullish positioning since the beginning of the data in 1995.

That's positive for the bulls. The caveat is that the folks I'm fading in this market, the wrong-way S&P 500 small traders, hit an extreme of bullishness the previous week - oops, bad timing, guys! - and they have yet to work off their excessive net long positioning this week. They've got to do that first before my setup can turn bullish in this market.

- Natural gas: This setup is bullish as of Monday's open and will remain so for at least two weeks. Nice timing, what with the massacre last week. People ask about the trade delays built into my trading setups based on the COT data. Both signals in this setup - based on fading the large spec net position and their total open interest - turned bullish on me the Friday before last. But there are trade delays for both signals. If I had acted on those signals this past week, I'd have been toast. The backtesting shows there's sometimes good reason to wait before acting on major moves in the COT data. I think the fact that markets don't react to the data right away - or don't do so right away in the expected direction - leads to confusion about the usefulness of the data. This last week in this market was a good real-time example. Thanks, backtesting.

- U.S. banks: My trading setup for the BKX U.S. Bank Index - based on the three-month Eurodollar contract (the interest rate, not the currency) - has gone bullish for Monday's open.

- Nikkei: This setup is still long - its sixth straight week - and now finds the small traders - whom I trade alongside in this market; no, they're not always the "dumb money" contrary to popular wisdom - boosting their net long position to an astonishing 4.08 standard deviations above the mean as a percentage of the total open interest. That's by far the most relatively bullish they've ever been. Wow. Something big could be brewing in this market over the coming weeks. Note the small traders operate with an eight-week trade delay in my Nikkei setup. So their extreme of positioning could take a little time to make itself felt. But when it happens, it could be a surprise.

-Crude oil: This setup has gone bullish, but not right away. Execution will be on the open of trading Monday, Aug. 10. See more details on the latest signals table.

Be sure to check in for an update of my portfolio page Monday. Good luck this week!

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

Data Categories Won't Change: CFTC

Got in touch with the Commodity Futures Trading Commission just now to ask about planned changes to its Commitments of Traders reports. The changes announced today, intended to promote greater transparency, include new disaggregated data for the commercial and large spec categories to better show how hedge funds and swap dealers are positioned.

But rest assured, the CFTC's Jay Huhman has emailed me. Existing categories will remain untouched, and the current reports will continue in the same format as before. The CFTC envisages releasing the extra broken-out data in a new report. Phew. Changing the categories would have likely invalidated most of the existing research into the past data - including my own - which wouldn't have had much usefulness going forward. Thanks, CFTC.

Oh-Oh... Wrong-Way Crowd Way Too Bullish

My coming S&P 500 bullish signal will be short-lived, according to the latest numbers from the weekly Commitments of Traders reports released this afternoon. You might recall that the "smart money" commercial hedgers had put on some very bullish positioning in their S&P 500 futures and options holdings last time around. (See my post from a week ago Friday for all the fascinating details.)

It turns out that bullish signal - which is to be executed on the open of Monday, July 20 - is far from being an all-clear for the market. The latest COT report shows the wrong-way small trader crowd putting on a huge net long derivatives position. So much so, in fact, that their signal in my S&P 500 trading setup has just flipped to bearish.

The small traders - that's the unfortunate little guys, who tend to get it wrong at key market turns and give all their money away to the commercial folks - bumped up their net long position as a percentage of the total open interest to 1.8 standard deviations above the moving average I use to gauge their sentiment. That's higher than any time since mid-Dec. 2008 - right before the big post-New Year bust.

Mind you, things aren't all that bad right now. The commercial traders are still big believers in the market - enough so to keep my S&P 500 setup from going all the way over to bearish. The setup will go back to cash after a week in the bullish column, as you can see from my newly updated latest signals table.

Other highlights:

- Financials: My trading setup for the BKX U.S. Bank Index isn't quite bullish, but the data has gotten nearly so. This last week, the large speculators - whom my setup for BKX trades alongside - significantly increased their total open interest, as you'll see on that latest signals table. Their signal has now gone to the bullish side. But this setup works with three different groups of traders, who all have to be aligned to get a trading call. And aligned in the same timeframe.

As it happens, all three signals are presently bullish. But the setup hasn't gone bullish because of a trade delay of two weeks for the signal based on the small trader total open interest. Two weeks ago, these guys were giving a bearish signal. If the other two signals can hold on to their bullishness for just a week longer, the overall setup will go long. But in these times, that's a big if.

- Natural Gas: After four weeks in cash, my setup for natural gas will go bullish on next Monday's open, July 13. The large specs have ratcheted up their total open interest big-time. My other signal in this setup - based on trading alongside the small trader total open interest - has been bullish four weeks. But thankfully, I don't just use a single signal for this or my other setups. My testing has found that often just hasn't been too reliable, statistically speaking. Natgas has gotten destroyed in the past couple of weeks, so I'm glad I booked a little profit and went to cash.

Good luck the rest of this week. See you back here Friday for more. And check out my portfolio page with an update on my single position's results.

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

Holiday Delay

This week's Commitments of Traders report is delayed until Monday afternoon because of the holiday in the U.S. Happy 4th of July to American readers! See you back here Monday.

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.