It has been a tumultuous week in the equity markets as news events and political gains have reduced the Chinese and Greek markets by 5% and 11%, respectively. Here in the US, an attempt was made to duplicate global markets on Wednesday but it was met with solid bids around Thanksgiving in the S&P 500 and Dow Jones Industrial Average. Meanwhile, Russell 2000 was supported near the key level of 1150 which has supported it since the end of October. Earlier in the week, we published a short article in Equity.com which suggested the expected weakness in equity markets due to the change in the position of traders over the past few weeks. This has led many to ask how we use this information to predict trade opportunities in commodity markets. We will use this week’s piece to explain in detail our perspective on today’s equity markets.
The discretionary part of the COT Signals Advisory Service is generally described as a three-step process. First of all, we only trade at the pace of traders. It has been our long-held belief of three generations that no one knows the commodity markets whose livelihood depends on the appropriate forecast of their respective markets. This includes commodity producers such as farmers, miners and drillers, as well as professional equity portfolio managers who use stock index futures and leverage their cash portfolios. Tracking the net position of traders provides quantitative evidence of the actions of both long and short hedgers in an individual market. The importance of their pure position lies in the collective wisdom of this trading group. Their collective actions summarize their shared access to the best information and models. The last part of the trade equation is to know the speed of their status. Their anxiety about buying or selling at a certain price level is as important as their net position. We only trade in the direction of trade speed.
The second step in this process is how we translate the weekly relevance of traders’ data into a one-day trading method. There are two main advantages of a retailer over a retailer. First of all, they have very deep pockets and have the ability to supply or supply basic commodities as needed. Second, they have a long time horizon. Think about the entire growing season or their financial year on a quarterly basis. Therefore, we must find a way to minimize risk and keep our capital safe. We do this using proprietary short-term speed indicators on daily data. Setup involves finding markets that conflict with the pace of traders from time to time. If trading momentum is stable, we are waiting for our signal to return to the short-term highs. Conversely, if traders are increasingly engaged, we expect the market to sell more in the short term. The short-term speed indicator is labeled in the second graph.
Once we have short-term buying, or vice versa, more sales are made Trade speed, An active setup is created. The trigger is pulled when the short-term market momentum indicator goes back and forth beyond the overbought / oversold limit. Waiting for a reversal provides two key elements to a successful trade. First of all, it keeps us away from running markets. There is a possibility of irrationality in the markets which does not even alert the traders. News events, weather and government information can all wreak havoc. Waiting for a reversal also gives us a swing height or lower which is necessary to determine the safety stop point that will be used to protect the position. The S&P 500 has a red or blue circle everywhere. In each circle, the highest or lowest value was the safety stop point. It is important to know the safety stop before placing any trade. This allows the trader to determine the appropriate number of contracts against his portfolio equity. Risk is always the number one concern for a successful business. Currently, the safety stop level is 17980 in the Dow, 1189 in the Russell 2000 and 2079 in the S&P 500.
Currently, the Dow, S&P 500 and Russell 2000 are all in similar situations. Given the high prices, it is reasonable to expect the recent rally momentum and recent global economic developments to push back from these heights. Clearly, traders, who were big buyers in the lower part of October, believe this is going to happen. We will focus on their collective wisdom as they have successfully called every major move in the stock market for 2014.
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