« Previous—Next »

COT Report Analysis

Author: Charlie Santaularia (info)
Website: http://www.parrottradingpartners.com
Posted: July 17th, 2007 at 7:56 am EST
Post your thoughts about this article. Click here!

Yesterday was an impressive day for the bulls. The Dow Jones Industrial Average broke through the 13,700 and 13,800 levels, which it had never even seen before (will we see them again? Most likely) before closing well above its all time record. The S&P 500 also reached an all-time high after several attempts at the old high. Heck, you could pick out just about any sector, industry, stock and talk about how good it looked on the p/l sheet. The street is giving much of the credit to Rio Tinto who offered $48 billion ($10 billion more than the Alcoa offer) in cash to takeover Alcan. Other credit goes to chain-store sales which came in better than expected, albeit from repeatedly lowered expectations. If you lower the expectations enough, you’re bound to impress someone. The last , and maybe most important, factor in the rally was the perception that traders were unwinding their short positions as to cut their losses or not miss the free train ride.

It was first brought to my attention early Monday morning as I ran through my routine of checking the previous Friday’s Commitment of Traders Reports (COT). I wrote an email to my partner, Jes, highlighting the reports and slyly mentioning that “the smart money continues to move out of this market, let’s be prepared”. I looked like a genius on Tuesday as the market fell 20 points and looked to move lower and press previous support levels. It was only two days later that I looked and felt like a moron for using these reports as de facto. Let’s take a closer look at the COT reports I’m discussing.

For those not familiar with the COT reports, here is a quick review. The COT reports provide a breakdown of each Tuesday’s open interest in the futures of the major commodity markets (i.e. what, coffee, gold, S&P 500). These are reported in a format established by the CFTC which includes three sets of traders; commercial hedgers, small speculators and large speculators. The data from these groups are gathered and reported as “net positions”. A negative net positions number indicates the commodity is short during the specific period while a positive net positions number indicates the group is long the commodity. Now take a look at the chart below.

This is a five year chart of the “net positions” being reported on the S&P 500 by large traders, or what we call the “smart money” as it includes large institutions such as banks, hedge funds, and other money managers trading a reportable amount of futures positions (currently 500 open positions). The S&P 500 index has been overlaid to show the correlation between the two.

Notice how the “net positions” number has dropped down to the lowest level we have seen since late 2004 to almost 40,000 short positions. This tells me the sentiment of the smart money as of last Tuesday was bearish. They have been clipping their long positions since the beginning of 2007 and boy have they been missing out on a great rally. OK, not all of the large traders are missing out, but obviously long positions have been cut. This is exactly what CNBC’s Bob Pisani was talking about yesterday when he quoted another analyst about the open interest in the futures positions being “at a three year low”. This is where the argument begins. Can the rally seen on Thursday be attributed to the smart money cutting their short positions and entering the market? The only way to see that is to analyze the COT report here in two weeks. Why not next week? Well, next week’s report will includes Tuesday’s open interest which most likely only added to the bearish sentiment as the 1.5% drop can attest for. It’s too bad these reports don’t come on a daily basis. It would make me feel like we had inside information on the overall breadth in the marketplace.

By looking at this COT report and talking with other traders, part of Thursday’s rally has to be attributed to the smart money covering their shorts. As the DJIA broke through to record levels, it carried the S&P and Nasdaq with it. As it broke higher, traders that were short realized they needed to cut their positions (either on their own admission or by the risk managers who hunted them down). That means they were buying into the strength, steadily exercising the market into thin air (see the five minute chart below showing the steady rise). Have you ever heard of panic buying or force buying? Well, we wouldn’t quite call this panic buying, but it sure felt like everyone wanted a piece of the action.

As the COT reports show, large traders have been exiting a resilient market and taking positions against new highs. Now that we have those new highs, it will be interesting to analyze these reports to see if the smart money returns to a neutral stance or if the move was enough to turn them into bulls again. We will continue to keep an eye on them and discuss the details in the upcoming weeks. Until then, be aware that we are still in a bullish trend climbing a wall of worry. The risk is not gone.

Post your thoughts about this article. Click here!

No comments yet

Leave a Reply

Name (required)

Mail (will not be published) (required)

Website

StockWeblog.com Weekly Update Newsletter Sign up now for weekly updates every Tuesday morning with links to our best articles from the previous week. Click Here to Register!