Commitments of Traders Report Predicts Dollar Strength

We’re swing traders, rarely holding a position more than two weeks. Even so, it’s important to understand the macro environment of the market being traded. The idea is to predict volatility expansion and market surprises in the correct direction, thereby providing a profit taking opportunity. Given the tremendous disagreement on the Federal Reserve Board’s expected actions by the general public and within the Board itself, it makes the likelihood of volatility expansion following next week’s unemployment numbers much more likely. Furthermore, it’s possible that the market could be handed consecutive reports pushing the market in the same direction, rather than instantly reversing course as has been the recent case with any two reports. This combination could push the Dollar through the last year’s resistance making the current weakness an opportune buying moment.

COT column bannerWhile we use the Commitments of Traders report on a short-term basis, the effects of their actions on the broader market’s movement are clearly illustrated on the included chart. The reason we’re able to put their leverage to work for our swing trading is that commercial traders are value traders. The cheaper or, dearer they see current prices as compared to their forecasts, the more they’ll pile into a given side of the trade. The action of buying more as prices fall or selling more as prices rally needs to be viewed in two ways. First of all, the term for this is, “negative feedback trading.” Importantly, this isn’t necessarily the same as, “adding to losers.” This is due to the number of players in the commercial trader market and the differences in their business operations and forecasting models. Thus, increased commercial buying on declines or, selling on rallies is frequently brought about by new hedgers entering the market rather than existing traders, “doubling up.” Secondly, this behavior has the effect of strengthening support or resistance as more commercial take action based on a growing consensus.

Commercial traders' value based actions can be very useful in the identification of trend trading opportunities.
Commercial traders’ value based actions can be very useful in the identification of trend trading opportunities.

Transferring their actions to the chart above, we see the classic accumulation and distribution stages of trend trading. This chart shows the accumulation of commercial buying at undervalued prices. Their buying provides support to push the market through the previously built up resistance. The unwinding of successfully placed hedges as the market moves in their intended direction follows this. Finally, the commercial traders become sellers as the trend overshoots their value area. Their selling creates the resistance necessary to cause prices to consolidate. Finally, the market trades sideways as trades are unwound and a new value area is determined.

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Based on the cyclicality of their behavior, we believe the commercial trader population is building support in the Dollar Index. Their willingness to take on new long hedges above 94.50 suggests that the long-term moving average support will hold and further weakness will bought as new long hedges are put in place. Finally, based on the range of the year’s consolidation, we still expect to see the Dollar Index trade north of 110. Furthermore, we’re expecting the recent low at 94.60 to hold. That creates a great risk to reward ratio for those betting on more rate hikes than not this year. Finally, buying on market weakness into the support of commercial traders puts us in a position to expect volatility expansion and surprise market events to occur in our favor as the consensus of those with the best connections and deepest pockets is on our side.

See for more details on our mechanical and discretionary Commitments of Traders trading programs.

This material has been prepared by a sales or trading employee or agent of Commodity & Derivative Advisors and is, or is in the nature of, a solicitation. This material is not a research report prepared by Commodity & Derivative Advisors’ Research Department. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions.

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