The Australian Dollar has slid nearly 9% in just the last month. We were exceptionally suspect of the rally that took place between February and April, as we didn’t see commercial trader confirmation of commodity demand, Australia’s primary industry, supporting higher commodity prices going forward. In fact, our data sources made us suspect of the entire metals and energy rallies we’re currently seeing come to an end. This is one of the primary values of tracking the Commitment of Traders (COT) report. It provides a tally sheet for fundamental supply and demand. Recently, we’ve seen some commercial traders nibbling at the long end of the Aussie Dollar and, given its recent decline, we feel it is due for a tradable, short-term pop.
We use the COT report in a few different ways. We track the net positions of the major market participants. We also track their momentum and the size of their total positions. We then combine this data to form a proprietary sentiment indicator that tells us just how anxious the market’s major players are to take action at a given price level. Their sentiment then provides us with the bias we use to determine if we should be trading from the long or, short side of a given market. This is roughly calculated as, “Commercial Momentum,” on the chart below.
We only take trades inline with the commercial traders’ momentum. The commercial traders are value traders who manage their positions according to their business models and market opportunities. Since we are short-term, swing traders, we attempt to leverage their market power at a given market’s turning points and this is exactly what we are preparing for in the Australian Dollar.
Let’s look at the chart below. The first point to make is that this is an entry technique using discretionary exits. That’s why the number of buys and sells on the chart don’t match. The power of this technique lies in the tension generated between general market movement and the broader commercial trader outlook. The process is fairly simple. When commercial traders are bullish or bearish, we wait for general market movement, which is more random in nature, to move against the commercial position by a given amount. Barring a rare case of commercial capitulation, we tend to see markets get bought or, sold out at the typical peaks and troughs. Once the market turns back in the commercial traders’ forecasted direction, as indicated by our short-term momentum indicator, we enter the market inline with their expectations. This puts us in the position of selling rallies and buying breaks which, is always a good place to start with a mean reversion trading methodology.
As you can see, the commercial traders have been buyers for three straight weeks as the market has declined. Furthermore, the market’s decline is washing out the long positions of the large speculators. This is classic interaction between the commercial and speculative traders and we intend to use it to our advantage. Once the Australian Dollar reverses higher, we’ll be looking for short-term trading opportunities on the long side of this market. We publish both discretionary signals like the ones above, as well as fully mechanical trading signals with corresponding performance reports at COTSignals.com. As such, we offer a free trial for the discretionary version to see how it fits your discretionary trading eye.
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