We track the Commitment of Traders report in four major domestic metals markets – gold, silver, platinum and copper. Currently, the commercial trader category is roughly bullish on the lot of them. Very rarely do we see all four metals markets telling us the same thing. While the markets may seem similar, their uses in both industry and investing provides each of the four with subtle nuances and slightly negative correlations that keep them from syncing up very often. Currently, the commercial long hedgers, the ones who take metal off the market for use in finished products or locked up in investments feel that the platinum market is a nearing bargain levels as it hasn’t traded this low since 2009.
Do you like buying into pullbacks and selling into counter trend rallies? Do you get that little antsy, slightly queasy feeling in the pit of your stomach wondering if it really was just a counter trend move and not a major turning point? Do you watch the markets intensely waiting for confirmation of a turn back in your predicted direction?
I’d like to share something with you that helped my trading substantially. I’ve been trading for more than 20 years now and in that time span, I’ve come up with three original ideas that work. Two of them I’ve been using for more than 15 years and the third has been a puzzle I haven’t quite been able to put together for some time.
Some of you, who know me, know that I’ve been following the Commitment of Traders reports for at least 15 years. The foremost expert in this field is Steve Briese, publisher of “Bullish Review.” His weekly publication and explanation of the different groups of traders in the markets and their corresponding tallies of accumulation and distribution are like watching the “Old Boys Network,” on TV. It is a quantifiable report on how the big money moves.
Steve’s main methodologies involve the Commitment of Traders Index, which reads like a stochastic and the second is Major & Minor Signals, which are based on a static jump or decline in the aforementioned index. His work and research is first class and parallel his character as a person. However, for any methodology to work, it has to be something the trader is comfortable with.
There are two main reasons I’ve never been able to implement this strategy as it stands. First, the problem with any stochastic or, index is that it is artificially bound between 0 and 100. There have been many times when the Commitment of Traders Index remains pegged at either extreme for months on end. This can happen in two completely different ways. First, the index can pick up a trend and remain locked onto it for an extended period of time. This is what we saw in many of the ’08 commodity rallies. The problem here is the equity swings. As a trader, I have to manage the equity in my account. Given the volatile nature of many of the markets, account equity fluctuates wildly, even in profitable positions.
The second problem with the index is that when a market retraces, commercial hedgers are quick to lock in their production and delivery prices. Their early action in these instances leads to an index reading that is the exact opposite of the market’s direction. Once they’ve bought all their raw materials and hedged all of their forward production, they’re done trading until the market moves back the other way, again. This leads to index readings of 100 in falling markets or, 0 in rising markets.
Thanks for bearing with me through the setup for my work. If you’ve read this far, you’re obviously looking for a more tradable solution. What I track is the momentum of commercial buying and selling. This eliminates the artificial boundaries of the index and allows me to compare the degree of buying and selling to the market’s history of commercial capacity for buying and selling. It also allows me to see, on a relative basis, whether there is more or less urgency in the market as we approach critical support and resistance levels. The advantage is that it helps put me on the right side of every trader’s number one question – “Resistance or, Breakout?”
When I combine the major market participants’ actions with my own proprietary trigger, I can pick off swing highs and lows with a greater winning percentage than I ever thought possible. When the Commercial Traders’ momentum is negative and my indicator says, “sell,” I use the most recent swing high as my protective stop point. This allows me to know what my dollar risk per contract is and allocate my equity more effectively. The opposite rules hold true for the buy side. When Commercial Trader momentum is positive and the market pulls back, I wait for the trigger to indicate, “buy.” I use the most recent swing low as my protective stop price. Again, quantifying the risk is one of the main keys to any successful strategy.
The last topic to address is, obviously, when to exit. This is a purely subjective task. In my quantifiable testing, trailing a stop one bar back has worked – once the market has moved in our anticipated direction. This is not how I trade it. I have the advantage of proximity on my side. I sit in front of the screens all day and watch the markets. I take profits on an experiential basis. Sometimes I’m early. Sometimes, I’m late. That is the nature of trading. There is no free lunch. I am happy to say that the more often I find myself on the right side of the market, the easier it is to be profitable and, after all, isn’t that the end game? I hope this helps put you on the right side of the markets more often and may your future trading problems be profit-taking issues.
The coffee market is what you’d call a professional traders market. It is a large and volatile contract, which leads to equity swings that are too large, even with a single contract for small traders to withstand. Furthermore, commercial traders dominate the market through their access to global information and deep pockets. The coffee futures market has been in decline since May of last year, losing half its value from the $3.08 per pound high. Even with the decline in volatility as the market has collapsed the average daily range over the last month is still nearly $.04 per pound which equals an average cash account fluctuation of $1,500 per day, per contract. Those wishing to participate in the coffee market without the use of leverage may want to look at the coffee Exchange Traded Fund – JO.
The May highs are a good place to start looking at the commercial traders’ forecasting ability in this market. The International Commodity Exchange in New York, formerly the New York Board of Trade held 1.6 million bags of coffee in their warehouses when the market made its high last year. Commercial traders sold into this rally and accumulated a net short position of more than 38,000 contracts. As you might expect, this left small and large speculators with their largest position of the rally, right at the top.
The next piece to look at is the Commitment of Traders Index. This is the most common tool used to measure the participation of the primary market participants; commercial traders, large speculators and small speculators. The index normalizes the total position to a 0-100 scale. Zero is the most bearish and 100 is the most bullish while crosses above 70 and below 30 indicate overbought and oversold levels and sets traders up with a trigger mechanism. This tool would have been of little use as the market declined since the index has been stuck above 70 for commercial traders since late September of last year as the commercial traders began buying to cover their short positions initiated last May.
This is why we analyze the raw data and scale it down to daily levels with appropriate stop loss placements. As a trader myself, I have to look for opportunities to maximize my time in the market and the less time I spend in the market, the less overnight or, news event risk I have to take on. We’ve picked up eight trades since last September using the daily method we publish with 6 of them being winners, including buying the June lows and selling the July highs.
Coffee hasn’t been this cheap since June of 2010. Coffee warehouse stocks at this time were 2.2 million bags and the commercial trader position was net long 26,000 contracts. Currently, warehouse stocks are 2.5 million bags but, more importantly, the commercial long position is now more than 56,000 contracts. This also sets a record in managed money short positions. Referring back to the 2010 lows, we saw the same situation without quite the levels of determination by the market’s participants and that imbalance led to a 13% rally in eight trading sessions and was worth $8,250 per contract.
I’m not suggesting that the market is immediately set to turn around and put $8,000 in anyone’s pocket by Christmas. I am suggesting that the coffee market is extremely oversold. The typical resolution to this market’s imbalances lies in favor of the commercial traders. Furthermore, any managed money in the futures market that has called for redemptions due to the pending tax changes will see their profitable positions offset. This could fuel some buying and get the ball rolling.
Finally, it’s important to track the markets’ players and keep track of the winners and losers. This requires a greater attention to detail than just a quick glance at a normalized index. Tracking the raw data for each trader category allows us to compare historical levels of trader involvement as well as tracking their movement relative to warehouse stocks to ascertain the degree of scarcity in a market.
We will be actively looking for opportunities to buy the coffee market and fully expect at least a tradable bottom being formed somewhere in the $1.40 – $1.50 range.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.