Commitments of Traders Data Suggests Wheat Bottom not yet Formed

As many of you know, our our primary focus is the analysis of the Commodity Futures Trading Commission’s (CFTC) weekly Commitments of Traders (COT) report. More specifically, our analysis lies in finding and quantifying unsustainable position imbalances among the trader groups. In the past, we’ve measured this against both historical levels and recent changes in actions in order to quantify both market sentiment and market capacity among the different trading groups. Today, we’ll provide Equites.com’s readers with a first look into our new method of calculation. Why we changed and what it’s current telling us about the Chicago wheat market.

We are swing traders. As a former floor trader, this is as far as I’ve been able to stretch my psyche. I feel that I’ve made progress as I’ve gone from holding trades from one to two minutes all the way out to one to two weeks. I’ve been doing this long enough to know that if the trader’s psyche and method are at odds, neither will find success. Therefore, the move to the new indicator is simply an evolution of the mean reversion, value based swing trading we’ve employed for years. The current evolution simply helps define the window of opportunity more successfully.

Ideally, we’re looking for unsustainable situations from within the individual trading groups. I’m a fair trader but a lousy programmer. Until recently, data feed/platform/indicator issues had limited some of my data crunching and hypothesis testing. That being said, the recent breakthrough has born fruit. Our new calculation method involves turning the individual trading groups’ net positions as a ratio, rather than an absolute. We use these ratios, which you see in the chart below, along with total position data to form a proprietary imbalance indicator. Basically, it states that once a market has reached a certain point in Dollars committed to one side of the trade, the market will either revert to its mean as anticipated or, blow through the opposing trading group’s resistance or support. The new calculation method provides a more timely indication of market imbalance as each data point is a static event calculated weekly.

The Commitments of Traders ratio imbalance calculation does a good job of identifying short-term tops and bottoms.
The Commitments of Traders ratio imbalance calculation does a good job of identifying short-term tops and bottoms.

Moving to the current situation in the Chicago Board of Trade’s (CBOT) wheat market the first thing you’ll note is that as the commercial traders buy in and their net position ratio rises, we will as well. The same is also true for the short side of the trade. We sell when commercial traders are selling and their net position ratio is declining. Obviously, there’s a bit more to it than this but this gets the gist across for a topic we’ll be developing over time.

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Technically, the CBOT wheat market has been tried to rally over the last couple of weeks. You can see that this was led by commercial buying, which appears to be giving up the ghost over the last three weeks. This left us in a setup with a declining commercial trader position and an overbought underlying market. This is exactly the window of opportunity we’re trying to define. Based on the market’s recent action, we see the rally’s failure to materialize as a developing bear flag triggered by yesterday’s decline. We’ll sell CBOT wheat and place a protective buy stop at the recent swing high around $4.32 while expecting this market to decline to $3.90 as an initial hunt for support.

 


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