COMMODITIES
The Smart Money? Follow The Dumb Money!
Timing The Market With COTs
by Alex Roslin
Who says you can't time trades using the Commitments of
Traders reports? This COTs-based mechanical system beat the NASDAQ by 728
percentage points -- with only one trade needed per year.
Ever wonder what the smart money is doing
in the markets? How do the folks with the best information and deepest
pockets invest their wealth? A handful of analysts and traders have found
an interesting way to tell. It's called the Commitments Of Traders report,
and its devoted fans say the report is the closest to a holy grail of market
forecasting they've found.
The COTs, as they're known, don't make headlines like those celebrities
of the world of economic indicators, the Consumer Price Index (CPI) or
the unemployment numbers. But a growing legion of "commitments analysts"
is glued to computers each Friday at 3:30 pm (Eastern time) when the Commodity
Futures Trading Commission releases the latest weekly COTs numbers.
The data, which used to be available only to paying subscribers but
is now free, shows how many of the world's largest commodity-producing
firms, index funds, and hedge funds are positioning trillions of dollars
of futures and options bets in more than 90 markets -- everything from frozen
pork bellies to the Standard & Poor's 500, orange juice, the Canadian
dollar, and unleaded gas.
But this treasure trove of insider information is hard to interpret
and not obviously usable in its raw form. The data doesn't appear to correlate
neatly with subsequent prices in the cash markets. What's more, analysts
don't agree on how to act on the data.
Should traders position themselves in the same direction as the commercial
hedgers? Commitments analysts often call these commercial traders the "smart
money" because they are presumed to have the best market information. Or
should we fadeÝ the noncommercial traders -- usually known as the
"large speculators" or simply the "dumb money" -- who are said to be positioned
the wrong way at major market turns?
Some analysts suggest the commercials and large specs are most useful
to watch when they take extreme net long or short positions, which often
suggests a market turn is imminent. But when is an extreme really an extreme?
Varying systems of measuring the extremes produce varying buy and sell
signals, many of which fail to make any money at all.
One popular approach is to trade with the commercials in the physical
commodities like gold and crude oil while fading the large specs in the
financial markets like S&P futures and Treasuries. But it's not clear
what data this approach is based on. Analysts who have devised systems
to analyze the COTs won't reveal their methodologies publicly because they
are proprietary.
And even these analysts generally say their systems don't give trading
signals per se. Instead, they suggest the COTs are best used merely as
an early warning system, which must be coupled with technical analysis
to time trades.
But a closer look at the data shows a trading system can indeed be devised
for the COTs. The results also suggest that following the smart money isn't
always the smartest approach. We actually need to know what the dumb money
is doing -- the really dumb money.
...Continued in the May issue of Technical Analysis of STOCKS &
COMMODITIES
Excerpted from an article originally published in the May 2007 issue
of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
Return to May 2007 Contents
