Watch For Shifts In Commercial Traders’ Biases

One of the primary differences between professional traders and amateur speculators is that professional traders are only focused on the bottom line while novice traders typically find themselves in love with the story of a trade and are far more concerned with “calling the move.” It is this mentality that also leads new traders down the illusive path of homerun-hitting trading programs.

Perhaps, the best example of this is attempting to profit from the short side in stock-index futures. The point here is that professional traders typically look for the easy money and could care less what market or side of it is being played. It’s an ego-less operation. This week, we’ll look at a way to at least protect equity gains, if not profit from outright short positions in the Dow futures.

The Dow futures are a thin market when compared to the Nasdaq 100 or S&P 500 futures. This lack of depth makes it extremely susceptible to shifts in commercial trader market bias. We track both the commercial traders’ raw numbers, as well as their momentum. The point is to ascertain how eager commercial traders are to get trades executed at a given price level. This helps determine exactly how bullish or bearish they might be towards a given market. The relatively low volume of the Dow futures makes the commercial traders’ actions within this market that much easier to trace.

The Current Picture

Here’s the current situation. Commercial traders have shifted their stance towards a negative bias as noted in the bottom pane of the chart labeled, “Commercial Trader Momentum” (see below).  Also noted on the chart below is the market’s behavior for the past year during periods of negative momentum. The Dow was up better than 9% for 2014 yet, for the 158 days that commercial trader momentum was negative, the total return was negative 1.83%. This tells us two things. First, there’s not much reason to be long when commercial momentum is negative. Secondly, when the commercial traders turn positive, the market really jumps.


Finally, as you can see on the chart above, not every period of negative commercial momentum provides an actual sell signal. It’s not our goal to catch every trade. Therefore, our entry requirements are fairly strict. We require the small speculators and index traders to push the market against the commercial traders, thus creating tension between the major players. In this case, the market has rallied enough to create an overbought situation in short-term market momentum against a backdrop of negative commercial trader momentum. Therefore, Friday’s close, which dropped the market back below overbought, created an official COT Sell Signal.


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