Technically Speaking: Early Warning Signs In COT Positioning

This past weekend, I discussed the surge in market exuberance in terms of both individual and professional investors. Of course, such surges in exuberance is generally indicative of the “capitulation phase” as the last of the “holdouts” finally jump back into a market which “can seemingly never go down.”

But therein lies the danger. It worth noting that despite the “hope” of more fiscal support for the markets, longer-term conditions currently persist which have led to rather sharp market reversions in the past.

“There are many factors from economic, monetary, geopolitical, and financial which have ignited each bubble, and bust, period throughout history. However, each bubble had in common the same extreme levels of confidence, exuberance, valuation and price extension that we see today. And they all ended the same, as well.”

Regardless, the market is currently ignoring such realities as the belief “this time is different” has become overwhelming pervasive. Importantly, such levels of exuberance have NEVER been resolved by a market that moved sideways.

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three key commodity-trading groups, namely:

Commercial Traders: this group consists of traders that use futures contracts for hedging purposes and whose positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and/or processing of the underlying commodity.

Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.

Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders.

This is the group that speculates on where they believe the market is headed. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to human fallacy and “herd mentality” as everyone else.

Therefore, as shown in the series of charts below, we can take a look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. With the exception of the 10-Year Treasury which I have compared to interest rates, the others have been compared to the S&P 500.