Many traders think technical indicators show momentum, or the direction of the trend.
That’s true. But these indicators can also show what traders are doing with their money in some markets.
Futures markets on broad market indexes, for example, offer data that’s not available for individual stocks. And right now, it looks scary…
Every week, the Commodity Futures Trading Commission releases the Commitments of Traders report. This report tells us who is buying and selling different commodities and futures contracts like the S&P 500.
Today, as part of our new weekly feature Technical Tuesday, I’ll show you how to read these reports and learn how big traders are positioned.
With this knowledge, you’ll have a unique perspective on what could happen next in the market, and can prepare better than those that don’t.
The Key Metric You Need to Watch
The Commitments of Traders report assigns all positions in the market to one of three groups.
Commercials are traders who hedge their positions in the market. We can look at the grain markets for a simple way of understanding this.
Campbell Soup, for instance, would be a commercial trader in the corn market. The company knows it will need thousands of bushels of corn in the next year, and they know when they need that corn delivered.
Rather than accept the risk of prices rising sharply, they can use futures to hedge their exposure and lock in prices they’re comfortable with.
Broad market indexes have commercial traders, too. In the S&P 500, commercials could be financial firms that need to maintain exposure to the stock market but want to reduce risks as much as possible. This could include investment banks or insurance companies.
The second group is large speculators. These are typically hedge funds using futures as an asset class to generate returns for their investors.
The third group is small speculators, which includes individual traders buying or selling a few contracts at a time — people like you and me.
The chart below shows the data for futures on the S&P 500. This is a chart of the e-mini contract which trades under the symbol ES.
Each one-point move in the index is equal to $50 in this contract, and the minimum margin is generally around $24,000. This means traders have highly leveraged positions in this market.
The numbers in the report can be a bit confusing, so I put together an indicator based on the raw data in the COT report. (It takes a little knowhow, but you can create the same indicator by plugging the COT data into the stochastic formula.)
This index grades the position of commercial traders, large speculators, and small speculators, on a scale between 0 and 100, with 100 being extreme bullishness.
The position of commercials is shown as the green line. The black line represents large speculators. Small speculators are in red.
In the middle of the chart, the index is based on six months of data. At the bottom of the chart, the index is based on two years of data. (To distinguish, I used less vibrant colors for the 2-year lookback.)
Now to what the chart tells us…
Large speculators were extremely bullish when this sell-off started. On the six-month lookback, the index was at 97.5. It was 100 on the two-year lookback.
While large speculators have been selling, they still hold relatively bullish positions with the index at 86 for two years and 59.6 for six months.
On the longer timeframe, small speculators are also relatively bullish, but they account for less than 4% of the market. If the selling continues, large speculators are the group that will be forced to sell, and their size will drive prices of the S&P 500 significantly lower.
As you trade the broad market, it’s important to keep an eye on the Commitments of Traders report to know how major financial institutions are positioned.
When you start to see weakness in the positions of large speculators and commercial traders, that can suggest a bear trend is in place.
Michael Carr, CMT, CFTe
Editor, One Trade
P.S. You may not know this about me, but I teach technical analysis at the New York Institute of Finance.
It’s where “Wall Street goes to school” — and even still, some of these concepts confuse my students.
So I know that, especially for those just getting their feet wet, this can all be overwhelming.
That’s why I spent 30 years studying and developing a strategy that simplifies options trading…
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Chart of the Day:
By Mike Merson, Managing Editor, True Options Masters
The day that gold bugs have been waiting for, ever so patiently, has finally arrived.
Gold is back above $2,000 for the first time since July of 2020, and with the way things are set up, new highs are likely in play.
Note how on the RSI, gold isn’t anywhere near as overbought as when it crossed $2,000 for the first time back then. Also keep an eye on the MACD, which is just starting to perk up.
Gold has had a lot of time to consolidate the big move that initially took it to $2k. Every day of waffling around has built up energy for this moment that we’re seeing right here.
Now, I don’t think gold will be prone to the types of massive bubbles we see in things like Tesla and Bitcoin. I’m not calling for $3k gold anytime soon. There’s just been too much de-programming of the younger generations for smaller speculators (as the COT report would call them) to suddenly start buying up gold bullion and junior miners.
Still, gold is recovering its reputation. It’s acting well in a time of crisis. That’s something gold bugs can and should celebrate.
Play gold for new highs here, with call options on GDX and GDXJ.
Managing Editor, True Options Masters