Trend Trading with the COT Report

As most of you know, we focus on swing trading opportunities both for our own accounts as well as the money we manage. We do this for several reasons and we’ll include a short-term setup at the conclusion of this piece. However, today’s main focus will be on using Commitment of Traders analysis within an existing trend to determine an entry point and time in the current soybean meal market. The lesson, however, works across all commodity markets for which Commitment of Traders data is reported.

In our swing trading analysis we typically refer to the commercial traders as, “value traders.” They buy on breaks and sell on rallies as they see the underlying market become cheap or, dear relative to their pricing models. Trend trading via the Commitment of Traders report requires a different mentality but focuses on similar qualities. Looking at the soybean meal futures chart below, you can see that the trend line T1 clearly defines the trend as downwards. However, notice the tremendous amount of commercial trader buying buying as the market fell to support at T2 near the year’s lows around $275 per ton. Clearly, commercial traders are eager to stock up on their bean meal needs at the lowest prices since June.


The commercial buying is clearly supporting the market at its current precarious position. Markets don’t like double bottoms and we don’t expect this one to hold. There are two primary reasons for this assumption. First of all, soybean meal hasn’t fallen nearly as far as any of the other grain markets including the underlying soybean contract as well as its derivative brother, soybean oil. Soybean meal has fallen by a little more than a quarter as compared to the dramatic declines in most commodity markets, some by more than two-thirds, since the 2011 bubble. Soybean meal has seen fairly steady demand from animal feeders who’ve been growing their herds since feed got cheap and cattle prices began to fall. Secondly, the commercial trader net position is far closer to their net long record than it is their net short record. This means that at best, commercial buying on new lows likely only to stabilize the market and not cause much of a reversal.

Commercial traders have been aggressive buyers near the lows creating a setup for a reversal higher. However, we don't expect this market to breach T1 and would consider a decent rally as a selling opportunity.
Commercial traders have been aggressive buyers near the lows creating a setup for a reversal higher. However, we don’t expect this market to breach T1 and would consider a decent rally as a selling opportunity.

160x600The stabilization created by commercial end user purchases should propel the market sideways to slightly higher over the longer term, perhaps, well into January. This will cause the market to extend itself back against the T1 trend line as time elapses. If we are right about the potential for soybean meal to fall even further, we will see a wave of commercial trader net selling as they even up their positions ahead of the next downturn. Remember also, that short sales initiated near T1 will be executed by short hedgers (crushers) looking to lock in forward prices for the coming business year in an attempt to lock in their revenue streams and adjust their prospects accordingly. This selling should be strong enough to switch commercial momentum back to the sell side. This would put us on the lookout for short sale opportunities within the existing downward trend and tie in well to the typical early year weakness associated with the U.S. grain markets’ seasonal behavior as Brazilian beans are brought to harvest and U.S. planting fears have yet to affect planting season.

We only trade in the direction of the commercial traders’ momentum. Therefore, we will look to buy  a short-term reversal higher in the soybean meal as commercial traders threaten their net long record against an increasingly short speculative position. However, this rally could be as short lived as the metals rally so, I expect profits to be taken quickly. Finally, once commercial traders begin selling, we’ll pile on in anticipation of soybean meal’s commensurate decline within the soybean complex and the grain sector in general.

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