Friday, July 20, 2007

Is The Smart Money Long Or Short Stocks?



Above we have a 5 year weekly chart of the e-mini S&P futures contract courtesy of barcharts.com.

There are 3 colored lines in the lower pane which represents the net positions of the 3 players in the market. The three players are the large, small and commercial traders.For this post lets just focus on the red line which represents the net position of the commercial traders.

If the red line is above the zero line, it means the commercials are net long, if the line is below the zero line the commercials are net short. As you can see in the above chart the commercials are holding their largest net long position compared to the last 5 years.

Lets take a look at what happens to the market when the commercials are holding a net long position of at least 100,000 futures contracts.

Back in February of 2003, the commercial traders were net long over 100,000 contracts and that was the bottom of the market.

August of 2003, the commercials were long and the market continued to rally for the next 6 months.

In June 2006, the commercials were once again long over 100,000 contracts and the market exploded higher over the next year.

So here we are in July 2007 and the commercials are holding their largest net long position compared to the last 5 years.

If you believe the commercials are the smart money and you believe in their track record (which I do), I would say that you would have to be very bullish on stocks in the months to come. I'd rather follow what the commercials are doing as opposed to some guy on television saying the market is overbought or that I should have sold in May and gone away.

There are many people who are bearish on the S&P based on all kinds of reasons ranging from it's the 7th year of the decade to higher interest rates. Those things may be true yet the market keeps going higher and when you look at the above chart it's hard not to be bullish on stocks.

As long as the market is making higher highs and higher lows and people continue to be skeptical about the rally, I will play from the long side and buy the dips.

18 comments:

Kevin said...

Love your good posts. thanks. read it everyday.

I agree with your assessement and I am very bullish on Nazdaq. I blog in Chinese(sorry you might not be able to read) and in Feb, I posted my target for Nazdaq 3100-3600, for 2007 and early 2008.

http://hi.baidu.com/investingmyway/blog/item/544a1c084eecc730e824885f.html

I do see a mini bubblish cycle that will happen. Let's see how it plays out.

Kevin said...

Hi,

Thanks for the nice comments..I checked out your blog and the only thing on there I was able to read were the charts..:-)

Trader mom said...

Kevin,
I love your work. Before quitting to raise my kids, I was an institutional equity salesperson and, before that, a banker at Goldman. I completely agree with your conclusions. I think the commercials understand we are in a unique, global buildout that will us upward in spite of our lackluster domestic market. Trade the peaks and valleys, stay out of housing (unless short) and play the upward trend.

conrad said...

Hi,

very nice observations, indeed. I am interested on how you obtained the charts from Barchart.com. I was not able to find the three components you are plotting. Coud you sahre them, please.

Thank you very much.

Conrad

Kevin said...

Hi Conrad,
I think you have to be a member of their site to see the charts.

Joe said...

Kevin,

Great blog and post which I also read daily. Would you want to comment on the fact that in other stock index futures like DJIA, S%P400 and Russel2000, the commercials have actually reduced postions recently?

Thanks, Joe

Kevin said...

Hey Joe,

I noticed the same thing...The COT positions for the other indices are painting a slightly different picture. I also noticed that the commercials haven't been as timely in the other indices as they are in the S&P E-mini.

All I could say is that the commercials have a very good track record in the E-mini so I'm going to focus on them as opposed to what the commercials are doing in the russell or DJIA. I know that's not the answer you wanted to hear but those are my thoughts.

HeadlineCharts said...

Hi Kevin, I read your blog almost everyday. It's terrific. Any comments on the high level of NYSE short interest?

Kevin said...

I guess a high short interest level is bullish from a contrarian point of view but I really don't base my trading decisions off short interest that much.

Joe said...

Kevin,

Thank you for your comment as well as the blog again - it's just great.

My thoughts on the current market situation are as following:

I do expect a correction in the fall about 10-15%. I don't think it has already started as the sentiment is too bearish after Friday's sell-off and the commercials in the S&P500 mini per your post are too bullish. I expect higher highs in the indexes accompanied by less and less momentum and width before it may turn late July/early August. Long-term I am very bullish.

Joe

Kevin said...

I agree....long-term I am bullish, however I do expect a correction in the market because the financials are so weak. If we do correct, I'd be looking to buy that dip and stay with the longer-term trend of the market.

George said...

I too follow what the commercials are doing but have found them to be inconsistent. Looking just at the chart you provided, I can note 6 points when the commercials were bearish to extreme bearish only to notice the market continued to go up despite their bearishness. (3/02, 6/03, 10/04,11/04,11/05 & 11/06). All these points the 'smart money' was very bearish and the market continued up. They are often wrong but followed by many as gospel.
There is a website I found that actually backtested the COT info and doesn't blindly follow what the commercials are doing. http://www.cotstimer.blogspot.com/
He finds the COT's generally bullish but the SP500 as actually bearish currently.

Kevin said...

Hi George,

You're 100% right, the commercials have been bearish and have been wrong many times...that is why I have never used them for sell signals in the S&P over the last 5 years..

I've been studying the COT data for many years across many markets and I've learned when to follow them and when to simply ignore them. I've also learned which markets the commercials tend to be the most helpful in terms of predicting direction.

It's not about just looking at the chart I posted and saying are they long or short and then jumping on the bandwagon. There are patterns in the COT report and thats what I look for when taking a trade. For example it's important to look at what percentage of the open interest the commercials represent. I also look at what the commercials do on a seasonal basis and then I look for something unusual to take place.. There are other little things I look at and maybe I will write about them some day.

Kevin said...

One more thing George, the commercials are actually bullish in the S&P right now, not bearish.

Here's the link.....blue line= commercials.

http://freecotcharts.com/charts/SP.htm

cep said...

Hey Kev,

I too am quite a fan of this blog and I look forward to including it in my morning reading for a long long time. Re: the commercials. Maybe a bit too simple and foolish but it seems as though they are better used to time into the mkt into mkt dips, vs. when the market is screaming higher. It just seems as though when the mkt has had a signiicant downmove and the com. have had a large net position, then the mkt has had an upmove. That has not always been the case (at least in this chart) when the mkt has already had a move to the upside. Additionally, I am very interestd in seeing this relationship over a longer period of time. This last bull mkt began in oct of 2002, almost exactly 5 years ago. Wondring what this relationship was like in the 70's when the mkt basically did nothing for 10 years.

cep said...

Sorry for the barrage, but one more thing. CAT, INTC,GOOG, MER,KO,JNJ, MO, MSFT have all traded lower since earnings. Aside from gold, where do you feel the leadership will come from? Even oils are not leading us up as the once were (OSX higher but XOI is lagging- also gasoline and oil are diverging as well).

Kevin said...

Hi Cep,

Actually if the market had a small correction, I wouln't be surprised at all because I see many stocks and groups not making new highs. Some of the weak groups are the financials and interest rate sensitive stocks.

If the market does dip, I will consider buying the dip because I know the long-term trend is up and the commercials are heavy long.

As far as leadership goes, I think tech or NASDAQ stocks will lead us higher along with the Asian ETFs.

Elaine said...

Hi Kevin,

Could you please explain who the commercial traders are. I assume that the large traders are the institutional traders and that the small traders are people like you and me, but who or the commercial traders. Thanks in advance for your reply!

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