Dec

30

We are in the midst of "silly season", when price moves have to be taken with a grain of salt. A speculator, who has strategic framework of what he wants to do through the holidays — and more important beginning Monday, January 5 — can try to filter out some of the price noise via combination of Open Interest (O.I.) and Commitments of Traders (C.O.T.) data, overlaid upon the price moves.

1. My intermediate view of the S&P is squeezed between two usual suspect forces: reconcile downtrend vs. degree of oversold. I ask myself: what may be the catalyst for reversal? The environment is awful: it's not enough that there is usual dark economic background –there is also a possibility that civilization may revert to the stone age: substantial stock values are simply impossible, if the financial infrastructure collapses — and it is teetering on the brink! The 2008 lows conveniently fell into 2002-2003 low territory — which ordinarily would satisfy FLAT CORRECTION pattern. Tragically, a collapsed individual Ponzi scheme is now shaking confidence about the remaining capitalist foundation — it dawns on the masses that Wall Street, shamelessly taking in taxpayers money, is in fact the ultimate pyramid itself; and so is the government! So I hypothesize that any conventional oversold to-date is temporary; it will lead to consolidation/bounce to relieve it, before the final down-wave. Today's C.O.T. had Commercials net-shorting again, during price down-tick no less! Funds were going Net-Long — my suspicion is that they'll reverse to selling into any nice bounce from here…

2. Treasuries of all durations hit what Chair termed "unconscionable" levels. I agree,  but there is a little hitch: Commercials have bought into recent record highs, putting pressure on Spec shorts! I'm anticipating the last little squeeze right here, coinciding with another silly Bullish headline and only then would Commercials begin reversing into the ultimate value! I'm not sure it will be as high as 147 on the 30y future, to rhyme with Oil's record tick; but I think at least the impression will be given — that's the target!

3. EU and SF are certainly on their way to eventual new records against the Dollar. It may be because they're currencies more diligently guarded against inflation; or it may be because the Dollar traditionally depreciated over time (except during brief historical German and Japanese tragedies). There is slight problem right now. C.O.T. showed funds jumping onto this idea a little too fast last couple of weeks. So I expect them to consolidate their profits for a little while… Spec sentiment against BP is nearing very oversold: it appears that Specs are pushing toward EUR/GBP parity; I will be very interested in picking up some pounds around there before Specs eventually go the other way… Yen is fundamentally very flawed currency; Japan demographics are irreversibly weak. It's only a matter of time before Yen strength reverses for good but so far we're not getting any strong indications. Clearly: it is because Yen has been trading not on its own fundamentals but rather as the default beneficiary on crosses…

4. Metals have been captives to currency moves; also industrial metals have suffered disproportionately sharp physical demand void and investor cross-margin liquidation. But Platinum's price has consolidated in Q4, while O.I. has much improved. Copper is even more intriguing: Q4 dip from 3.25 to 1.25 came on increased O.I. and uncharacteristic record Fund Shorting(!) I have to conclude that metals are very near cyclical bottom but timing of any major rally would still be tied to currencies. Gold may still have to spend another Quarter or so in roughly 750-950 range, before breaking out to records with currencies; so range is what I will trade, siding with Commercials…

5. Energies are very interesting, as they are nearing very important bottom. Sentiment swings are most prolific here - as they are true strategic commodities. In the world that appears to come apart at the seams - there will eventually occur government hoarding "Mad Max" style! Both Crude and NatGas hit nice natural bottoms last week. WTI managed symmetric equality drop, you can't make this stuff up: $57 slide to $90 by Fall Equinox; then another $57 below $90 by Winter Solstice! NatGas completed 100.0% Lobagola $5.20 to 13.70 back to $5.21 - price, which equals precisely 38% of $13.70! So all of this is nice; except Crude is currently sporting C.O.T. Bearish divergence, and NatGas is sporting O.I. Bearish divergence. My conclusion is that both will struggle a little in Bearish wave2 - before Bullish wave3 rockets them in January… We are in the midst of "silly season", when price moves have to be taken with a grain of salt. A speculator, who has strategic framework of what he wants to do through the holidays - and more important beginning Monday, January 5 - can try to filter out some of the price noise via combination of Open Interest (O.I.) and Commitments of Traders (C.O.T.) data, overlaid upon the price moves.

Dec

30

Over a decade of pro checkers training followed by two decades of value-hunting in markets taught me but one lesson: Trojans should ring alarm-bells.

One should be cautioned against too obvious a bargain, just like when your checker opponent offers a sacrifice. I view the thoroughly obvious Bond Shorting bargain as one of the ominous signs that will keep me away from Times Square for the Ball-Drop. See, a friend of mine cancelled his well-planned Mumbai biz-trip — just because of what happened there the month before. People's tendency is to be reactive; not pro-active…

With what Israel is currently doing, Hamas is effectively paralyzed. What people are not thinking about: when you corner someone, things may become a little more complex than meet the eye.

Dec

27

1. What is the exact physical principle that makes triangles laid on their sides so strong relative to other shapes and how does this relate to market movements?

2. What is the correlation between the two year change in the S&P and the subsequent one year move, and how has this changed since the 1970s?

3. How can the sharp upward continuous move in the 1950s and 1990s in S&P be reconciled with the well known two year reversal tendency?

4.  Is there any support for the idea that the best strategy in one year is exactly the opposite of what worked in the last year?

5. When will the asset allocator boys change their mix of stocks / bonds back to its "permanent level" now that stocks are down 30% and bonds up 30% from the previous year? Of what relevance are the moves in the market in 1908 and 1909 vis a vis the 40% decline in DJI in 1907 as a comparable to present? Will the reaction to the employment numbers month by month this coming year be opposite to the movements last year, starting with the January 2007 number which was the beginning of the end? How will all the liquidations related to the purported 50 billion fraud work themselves out in the market and have they all been discounted? When will the Nebraska conglomerate sink to a price to book value ratio that befits its status as a firm or man whose mission is not in accord with the future?

Anatoly Veltman responds:

The biggest problem I see for 09 Bull is reconciling investing into paper assets with fear of:

1. …misappropriation

2. …government itself

3. …devaluation

I was previously looking for correction to previous trough as thoroughly sufficient — for Vic and Laurel's bullish quantitative (historical) considerations to kick in. But given both the government and human heart-breaking experiences of 2008 — I tend to think 2009 will not be the easy "intermittent" rebound.

Perry Metzger answers Question 1:

Triangles don’t deform easily because all triangles with a given side length are congruent — there is no way to deform the angles without deforming the length of the sides. This is not true of, for example, quadrilaterals, where you can deform the angles without deforming the length of the sides. I have no idea why any of this would be at all relevant to market movements.

Dec

16

The following pairs are testing interesting short-term speculative milestones in front of the historic FOMC announcement:

EUR/USD retraced 38.2% of its fall from record 1.6040 -> 1.2335
DXC retraced 38.2% of its H2 2008 advance 71.31 -> 88.46
USD/CHF is breaking trendline drawn through 7/15 and 9/22 extremes EUR/CHF retraced 62% of 1.6828 -> 1.4300 12-month drop EUR/GBP is at 0.9020 record double-top Feb Gold retraced 62% of Q4 2008 938.8 -> 688 drop US Treasury yields are at record lows from 2-y to 30-y

So while there is a myriad of qualitative considerations: to include unprecedented world-wide credit squeeze, government and crook interferences, holiday "silly season" and year-end repatriation - we are about to assess the veracity of certain quantitative speculators.

Dec

16

Cot Chart

Thanks to Steve Ellison for this very impressive overlay ! My immediate guess is that in true trending market (which SP has been since summer - down), Commercials do prefer trend-following. Once market "trendiness" changes (to swing-market), Commercials should shift into fading mode! Just a first guess..

Dec

1

A VAs the S&P begins its advance off of the decade lows, we find a telling indicator in daily Open Interest breakdown. We just completed five straight up-sessions, beginning with the 11/21 Fri bounce from the 739 low: O.I. in bigSP and E-mini were little changed. On 11/24, a powerful up-day: O.I. in bigSP was up big, E-mini's down. 11/25 up-tick: bigSP O.I. up, E-mini down. 11/26 big up-day: but bigSP O.I. slightly down, E-mini's down. 11/28 up-tick: bigSP O.I. down, E-mini's up.

So, the observation of this five-day bounce showed that bigSP players correctly went Long early-on and then basically aborted up-higher; while E-mini players did the opposite!

Nov

25

I must confess that I've been approaching the futures board from the Long side of late. I heed signs of climactic Bear sentiment:

1. Most stock indexes reached long-standing target of flat correction, having traded back from record -> 2002 lows. Most people, though, continued to use the same approaches as they've employed at significantly higher price levels (at 100% higher levels, bluntly speaking).

2. Certain prices are preposterous. Prompt gasoline traded below $1.00 down from $3.63 record July 11; four months move! Copper swung from $4.08 to $1.52! One must remember that, as opposed to individual stocks that have proven their theoretical potential of wiping out,  this simply can't happen to raw materials. Swiss Franc depreciated whopping 25% in same period, which is way too much; but raw materials by 62% !??

3. Despite 30-90 day T-bill rates at literal zero, people appear to have bought into the idea that yields may go negative. I took Central Banking from Lorie Tarshis (who studied under and later worked for Sir John Maynard Keynes himself). Lecturing in 15% prime rate environment, Lorie shared his experience of persistent negative T-bill auction yields that followed the 1929 crash. It sounded exotic, and people hardly believed my story over the years; but here and now, suddenly everyone believes this possibility! My sense is, given modern financial sophistication vs. early 30s,  why would it come to that this time around?

4. Even if the economy and corporate margins stagnate forever , why wouldn't dollar-denominated nominal prices of everything, including listed stocks, rise? There is obvious $-debasing going on; purchasing power of paper currency units will hit the skids…

5. Then, there are shorter time-frame sentiment observations. E.g. Monday's Open Interest in E-mini futures decreased 1% on rally (definition of short-covering); but big S&P Open Interest rose 3% during same day's advance! To me, institutional traders have started to accumulate Longs, while Small Traders are too busy just short-covering!

6. From its new decade's low, the S&P is beginning to rally through 38% retracements and aim at 50% ones. It's also beginning to only pull-back 38%. Of course, there will be more scares to come in many areas and shoes to drop, but I can hardly bring myself to approach the board from the Short side strategically.

Nov

14

F & SOver and over again, we see the market moving in trepidatious concert with the father figure of the moment. It used to be the fake doc and then it was the scholarly economist chair, and now it's the former chair of the white shoe firm that maintains the Chinese wall with its former colleagues. On past occasions it's the Sage, and every now and then, a big executive like the head at Intel or the basketball player from Conn.

What's particularly damaging to the market is when these people bow. The spectacle of the Intel chief bowing and begging forgiveness I believe forever tarnished the aura of high p/e deservingness that his company with 59% profit margins might have deserved. The news that the former white shoe chair knelt in front of the chair of the Democratic party and begged her to pass the bail out bill was the death warrant for the market for a time. And now that he changed horses in midstream and gave up on buying mortgages directly, a position he had previously begged for, "based on a different set of circumstances" was the death knell for the market.

The trader has the Dostoiyefskian tendency to feel guilty about their activities from the time they were small. And they wish their father figure to be strong and not to kneel. When these figures regain the respect of their kids by being strong, maintaining the stiff upper lip, etc., we can expect a much better market. How would you quantify this and what other instances of kneeling as a bearish indicator have you seen?

Anatoly Veltman writes:

You mean like when Chancellor of the Exchequer raised discount rate 9/16/92 three times (from 3% to 7%), before rolling it back to 3% by the end of the same day… and recognized that ERM snake was in fact beheaded?

James Lackey replies:

The return of the dipsy doodle is a good start. The most damaging current meme is that the markets are at fault…  and market prices do not forecast. "Free markets need help and regulation from governments," The dog is chasing its tail. Government regulations are what cause markets to come up with crazy schemes to avoid the previous market patches, in Microsoft terms, a "hot fix."

A more direct answer is price discovery. Once we all figured out too many prices were rigged they panicked and traders bought as usual. Then when the father figures changed the rules to bailout their kin, we went on strike. No traders, no liquidity for the markets. Now the prices are caught in the crossfire of the Hatfield-McCoy feud. Do not blame the hired guns.

Art Cooper adds:

Obviously the market and economy respond positively to strong leadership, as this relates directly to human emotions (animal spirits) which are so essential a part of Main Street economics, finance and the financial markets. Hence, the Great Depression market responded positively to a strong leader who declared that "The only thing we have to fear is…fear itself," even though his economic policies were in fact counter-productive to recovery (see Jim Powell's "FDR's Folly").

Kim Zussman interjects:

The child is racked with disorienting insecurity when they first witness their parents own uncertainty, indecisiveness, and fear. Now the children are being dragged by their mother to a new daddy with undetermined rules of discipline, while being told that the last daddy was really an immoral fraud.

It's hard growing up, especially with a fickle mother.

James Lackey writes:

I listened to Santana's show tour warm-up in 2002 or so. Later that evening he was on an interview, local radio, and was describing his so called comeback. His rebirth was through collaboration with new young artists. His quote went something like, "I wanted my teenage kids to know dad can jam, and how the system works, sure they saw my old awards and shows from back in the day… but to a teenager..it's now that counts." The gist was, the only reason he did the work was to prove a point to his children… boom… the return of a father figure.

J.T Holley writes:

Highly apropos, like all great literature, call me crazy if ya'll don't see it that way, this has been written in William Golding's Lord of the Flies.

Kids abandoned due to crash from adults.

Ralph pleads with Piggy about Simon's death: "You were outside, Outside the circle, Didn't you see what they did" (paraphrased).

Piggy before his murder: "Which is better? Law and rescue or hunting and breaking things?" (paraphrased). Then the rock falls.

Kids rescued from abandonment and panic/chaos when Ralph looks up at Naval Officer (adult).

I guess the big question right now and maybe one that Golding proposed is who is going to rescue the naval officer and his boat? In other words who saves the adults themselves?

Now substitute War, Atomic Bomb, Ralph, Jack, Simon, Piggy, Naval Officer, Naval Ship with traders, investors, banks, citizens, government, and politicians.

Kevin Eilian writes:

Before it became a quote dejour by Mac and others, R*bin's upper lip, bone straight poker face, "the economic fundamentals are strong,"– you believed it. He made sure he did, too, as his net worth was tied to white shoe IPO.

James Sogi says:

Demographics is the counting of the "father figure" issue. We saw the effect in the aging of Japan. Now we are seeing the aging of America. The rest of the world is quite young, averaging something like 15 years old… Many of our parents are sick, old or dying or died. There is a changing of the guard. The boomers are retiring. America is aging and gaining weight. Though America "the great white father" is kneeling or brought to its knees, the emerging world will rise in its place over time. I would watch this trend over the long term. The world is becoming multicultural. Witness, O witness, the non white majority in California.

Russ Sears adds:

I have been thinking for the last few weeks that all of this could have been avoided if the investment bankers had learned a few lessons on risk management from a mother of a smart, curious two year old or a teenage boy. You can't just tell them no and then ignore them once they've moved on and not still expect some experimention to happen. The alerrt mom always seems to have an instinct, before the father, when silence is a clue they are into something or when the truth has been stretched. How the mother always is prepared to contain while still delighting in their first taste of chocolate cake or discovery of girls and love. The good mom has the sense to help them limit these new found divine obsessions, before they ruin their mental and physical health.

Nov

3

1. In the old days, one had to take account of the high and low of intra day prices because the range could be 4% and the market could change by 15% in a year. These days, the 5 minute prices often move 3 % and the hourly prices 7%. Again that is 25% of the yearly range, but this time within a 10 minute or hour interval. The idea that one can buy or sell within the day based on what happened yesterday or what you expect tomorrow is a terrible fallacy.

2. One of the biggest mistakes in markets is to worry about how much is for sale or demanded at specific prices. This is the source of the reason that the Teutonic - - - - -  savant who used flow of funds was always wrong about the interest rate moves the next year. Also, the idea that prediction markets can be manipulated by an interested large buyer or seller to their discredit is another speculative canard.

3. There has been a terrible increase in interest rates in the last week, and unless this is dissipated the market is not going to Lobagola and back as quickly as it would until fear and pessimism brings the expected future rate of inflation down to a level consistent with the recent and inevitable Julian Simonesque predicted decline that just occurred.

4. One of my most astute employees bought a company and brought it public and had a tremendous gain and desperately wanted to sell. He sold all he could and more, but the analysts would always say, "Why are you selling if the company is so great?" He had a good answer . "It's because you guys wanted me to provide liquidity and diffusion of ownership out there." I am reminded of this as the CEO's talk about how reluctant they are to put a cap on bonuses or raises. (We have to keep the talent.) They will as reluctantly agree to foregoing these bonuses as Brer Rabbit was reluctant to be thrown into the briar patch.

5. Has there ever been a time when the enterprise system has been in greater retreat than now, and how will prices adjust to this change in tempo and paradigm? One can always recall that during the French Revolution, the equities apparently went up the most after diamonds (one must check this).

6. Here are some books I am reading and recommend. Sam Wyly Entrepreneur to Billionaire. It applies the insights of football to making money and explains why so many football players achieve great success in business if they live long enough to get there. Leaves in Myth, Magic, and Medicine by Alice Vitale. It shows for the layman how the simple structure of leaves and blood are similar, and the unity and connectedness of all things, and provides a foundation for growth and life. Almost a Miracle by John Ferling. Finally shows how the British managed to lose a war they could have won so easily if Aubrey had been involved. The Enzyme Factor by Hiromi Shinya. No matter how many times I read this wholly unscientific book, I always come up with something worth testing that almost invariably turns out to be true, including his avoidance of dairy. Difference Equations by Paul Cull, Mary Flahive, and Robby Robson. I believe that difference equations are the best mathematics for market people to know. Prices are not continuous and they follow the last x ticks in a fully orderly difference equation.

The problem is that there are systems of simultaneous difference equations going on at all times and they are always changing. I have about a dozen books on difference equations, and I am always so hopeful when I start them, as each one has a different notation, and triple summations with very small differences in the top and bottom. Index numbers must be gleaned and put in the context of difficult to remember formulas for infinite series. This book however is the best one and it covers all the topics we usually read about in the modern math like chaos and rates of convergence, and periodicity in a fully accessible fashion. A very good discussion of many different approaches to the basic second order difference. The Fibonacci equation is nice as is their extension to graphing theory.

7. One of the hardest things that every kid goes through is to change teachers in tennis or music et al when they outgrow them. It happened often to me, and I still remember the trepidation I felt when I dared to change from Rubell to Nogrady when I was a tennis hopeful, or from L. Taylor to Mosteller when I was an undergraduate. This preparation however, like most things that kids go through is essential for success in life. There's nothing more important than giving up the old for the new and better in markets. Many turn now to those who believe in bear markets, and rising commodities, switching out of stocks when they look bad, and the underpricing of volatility as their current mentors. Who can blame them? They look good now. Even the weekly columnist who took over in 1966, who as far as I know has never written a bullish column, has finally been vindicated after 42 years. The problem is that one must always look forward and I have never found a qualitative analyst whose ideas were consistently good. They have their day, they attract billions from their followers, and then make their contribution to the market cycle, losing a net of billions in the process while still maintaining a high internal rate of return.

Russ Sears writes:

The beauty of the predictive markets is that very little explanation of your vote in $ is allowed, except the amount bet. But on stock markets, I would disagree, it is the natural tendency to follow a leader. This should be clear in the election season. But also clear should be the tendency to lead one down the wrong path. Further, madness of the crowd happens when the masses favorite analysis is confirmed by the leaders. Or the experts. It's incredible to see how much money was wasted on models and analyses whose purpose was to confirm decisions already made. This of course in now blamed on the modelers, not the decision makers. The greatest mistake is to believe your analysis must be right because the crowd is following it, for the moment.

Anatoly Veltman adds:

A VeltmanI understand what you're asserting. At the same time, there are subtle differences at times. For example, it has become known near Fri close: that Small Specs have Net Shorted the futures trade around the 825 S&P contract low. The S&P has been creeping up since, without material corrections that would allow them comfortable cover. This sure increases probability that they'll end up covering uncomfortably.

If, to the contrary, the Commitment of Traders (C.O.T.) report indicated Commercial shorting into the lows — then there would be less reason to be afraid of panicky cover to ensue. After all, hedgers are rarely forced to cover…

Oct

22

VNThere are many unprecedented events that we are witnessing these days. To me, the most amazing is that on 12 31 1982 the Nikkei closed at 8500, by no means a local high as it was 9000 a year later.. On 10 15 2008 it closed at 8458 thereby marking a 26 year period where a major enterprise stock market moved without a rise. The S&P stood at 800 to 900 in mid 1997 and reached 1000 in early 1998. Thus, 11 years without a gain in the US. Is there a single overriding reason?

To me, the key aberration occurred in the two weeks of 9 26 2008 to 10 10 2008 when the S&P moved from 1218 to 891 and the Nikkei plummeted from 11920 to 82760.

To gain perspective, I looked at weekly prices:

date       sp     nikkei    bonds    euro   crude gold   wheat vix

0919     1246    1192       118 5   14466   10254  834   718   32

0926     1216    1189       117 1   14609   10618  879   716   35

1003     1108    1094       11920   13772    9301  835   640   45

1010      891    8276       11620   13408    7799  849   563   56

A preliminary insight is that vix and the dollar rise and crude were the major harbingers of the unprecedented decline the week of 10 10.

I always believe that markets and prices are the key and that interrelation and the web is always there. The problem is they're always changing. But at least we've got a description.

Anatoly Veltman adds:

My hypothesis at this hour is that the currency markets are destined to wash-out first, with world equity markets grudgingly following. The reason, obviously, is that margin liquidation in FX takes plays instantly - while generating and then instituting collection on stock margin calls takes time, not to mention timezones.

Kim Zussman wonders:

Couldn't help wondering when/if backbone financial theories (such as high allocation to equities for long term investors) will become so unpopular that demand for courses in financial markets will dry up. Y@le had a guest lecture from David Swensen earlier this year, will he be invited back next year?

Charles Pennington comments:

For any remaining fans of the Fed Model, here are some numbers from the Financial Times (page 23, "Market Data"):

country      earnings yield %      10-year gov't bond yield %
US                         8%                3.7%
Germany               10%               3.9%
UK                        13%               4.6%
Japan                    9%                1.6%

J.T Holley writes:

body snatchersThe web now includes for me the Vix trading higher than a barrell of oil at one point, and for me a first, the cash trading more than the Dec mini S*P contract. What is next– dawgs n catz sleepin' together? Be very very careful, brainwashin' is in effect and bodies are being snatched!

Stefan Jovanovich replies:

Starting the Index of home prices at 1995 overstates the run-up of home prices. It would be like starting a stock market Index at 1982. Kim may disagree, but house prices here in California in 1995 were still recovering from a boom-bust cycle that was almost as dramatic as the current one. The current boom didn't really get going until after the dot.com bust; 2002 was really the first full year when housing prices only went up no matter where they were.

Time for Oscar Hammerstein and Carousel (first sung on Broadway by Jan Clayton aka Lassie's Mom):

"When you walk through a storm,
Hold your head up high,
And don't be afraid of the dark,
At the end of the storm is a golden sky.
And the sweet silver song of a lark.
Walk on through the wind,
Walk on through the rain,
Tho' your dreams be tossed and blown,
Walk on, walk on, with hope in your heart,
And you'll never walk alone.
You'll never walk alone :| "

Time to buy because it is way too late to sell, and all the canes have been swapped for walkers.

Oct

20

A VeltmanFor the week 10/7-> 10/14, during which SP futures traveled 1006-> 837 and back 837-> 1002, the Net change was Long in Commercial category, while Short in Small Spec. We don't get any direct signal, as market entered consolidation and is no longer short-term stretched out. However, we note marked change in sentiment:

1. Small Specs now tend toward Short
2. VIX has risen substantially
3. Futures do not maintain premium at US close.

So, as opposed to early October, when we could find little sign of short-term capitulation at 1100+ pricing, we can see plenty of that now, at almost 200 points lower pricing! There were few strong signals elsewhere. Of note only firming EUR, Gold and energy Commercial support.

Eht Yob asks:

Why do you refuse to test these data? It is so easy and you will find that small speculators' positions have almost zero predictive power to future movements of the S&P 500. Is it because you are too lazy or is it because you are a salesman and really don't care about the future outcome? Or is there another reason?

Anatoly Veltman explains:

1. A quality test is not as easy or cheap as you portray.
2. I don't believe COT will test profitable anyway.
3. COT can be extremely useful to a competent discretionary trader.
4. Useful exactly "because" it should not be used as primary, but only as a filter to original solid ideas.

Isam Laroui adds:

Why so much hatred, Mr. Yob? I, for one, find Anatoly's COT notes very instructive. As he says it's just one tool in a trader's toolbox. Just the fact that most traders look at it is reason enough to stay informed. No one is telling you or anybody else to blindly follow some kind of mechanical trading rule using COT data.

Eht Yob replies:

What you don't understand is that I do blindly follow a mechanical trading rule using the COT, and what I'm pointing out is that the data are very useful, when analyzed correctly.

Oct

13

veltSP ideal downside target of the entire Elliott Flat Correction from 2007 record of 1587 lies near 2002 low of 768. My feeling is that lack of clear technical indications and overall regulatory uncertainty will combine to reduce trader activity and directional movement. Subsequent chart action will likely become more grinding, thus eating into implied volatility. In the interim, one should take count of the entire crashing wave as it developed since the "mother of all short-squeezes" on Sep18-19.

Intraday chart of E-mini dissects the waves of the ensuing three-week fall: we have entered wave 4 consolidation, which should retrace toward 966 or max.1006 rally objective. Note previous four rally attempts: each squashed by size offers in Globex order books at precise 38.2% retracement levels. By the way, most of those "timely size orders" came in similar suspicious pattern: "insider" short-covering commenced off of 9/24, 9/29, 10/6, 10/8 lows; followed by bullish announcements of unprecedented government actions - and then stonewalled by the 38.2%-retracement size offer! Following tremendous short term oversold, the pattern was tellingly modified this Friday: to offer only 50% bounce after US pit open, and then a 61.8% bounce near pit close!

Oct

11

holidaysWhy do you hypothesize the Tel Aviv market rose before the holiday? Yom Kippur prayer, as Prof. Schnytzer suggested? What else do they know?

Adi Schnytzer comments: 

I simply couldn't come up with a better hypothesis. I guess you get so low that up is the only feasible direction left, right?

Nigel Davies responds: 

I think there's a flaw in this logic. The concern here is 'system failure,' which if it happens can mean that the profits from being short may be worthless anyway. Who knows, under some kind of post system martial law, short-sellers might even be rooted out and put on trial…

In my view there are two long bets; long the system's surviving and long personal/familial survival in some post-apocolyptic nightmare. So the most reasonable hedge is to buy survival items like freeze-dried food, blankets, medicine, weapons, a horse, some chickens and a couple of goats.

Anatoly Veltman adds:

A VeltmanYou are thinking of V-shaped bottom. Of course, other shapes of bottoms have occurred in history of every contract.

V-shaped bottom's dilemma is that environment created in course of a rout doesn't facilitate one's large reversal position - even if one correctly times reversal. The entire ecosystem deflates; so due pay-off will not be mathematically possible in favor of the bottom picker.

Theoretically, this should not be the case vis-a-vis a trendfollower, who correctly stays short all the way down, possibly even pyramiding. Except in 2008 — when shorting became restricted.

Sam Marx adds:

I agree regarding Cramer but in this downdraft we don't know how far it will go even if stocks are undervalued now. But stocks have a tendency to overshoot at opposite ends.

In '87 when there was a one day sell off of approx. 23% I was clearing through a firm that had its start in commodities and the head of the firm was almost in tears claiming that the stock market was vicious compared to commodities. He gave up clearing and bought a bank in Chicago.

I saw Mike Huckabee on Cavuto's Saturday program say that a "knowledgeable" friend of his suspects "economic terrorism" is behind this sell off.

In the end, undervalued stocks with growth potential will come back in price. That's the basis of Buffett's large purchase of KO (Coke) in '87. The stock was driven down by being part of an index where arbs bought the index future and sold a stock basket that included KO.

In '87 on the floor after that big one day down, I sold overpriced far month out of the money calls and bought an equal number of shorter month calls at the same strike price. Both were grossly overpriced. The plan was when the volatility dropped because of time the spread decreased and I unwound them. As a saving grace if the stock started to move up the volatility would've dropped and I could also unwind at a profit.

Oct

11

A VeltmanThe three-day latency wreaks havoc for those who try and use Commitment Of Traders report for forecast, rather than just for objective description of preceding market composition. SP slide 1169-> 1006 (down 13%), included in five-session move ending 10/7: uncovered Bearish C.O.T. divergence of unprecedented degree! To sum up regular+miniSP: Commercial Net Short rose 64,000 regular SP contracts; while Funds Net Long rose 30,000 and Small Spec Net Long 34,000! Also unprecedented was Small Spec desertion of commitment overall: their "Net Long hike" resulted from halving of their entire futures Short interest! All this certainly explains subsequent past-10/7 rout, which brought SP further down 1006-> 891 (another 11%), since the period of report capture. Who knows how commitments might have changed over the past three days…

Throughout the panicky activity of the past month, there was un-paralleled number of attempts and methods to account for past and predict future. One can't hold oracle status in all areas of fundamental, technical, historical, philosophical, social and political analysis. What piqued my curiosity — and I must admit, it was not for the first time in my 22 years of 24-hour vigil (i.e. some 200,000 hours of real-time markets): the Commitment of Traders, heavily flawed and latent by definition — did filter out Stock crash, Currency crash and Gold/Treasury "non safe-haven."

Oct

1

A Veltman1. At 11:09 this morning, E-mini stopped her collapse — just as she bottomed at 1143.75 = 50% retracement of 1112->1175.75; why — I don't know…

2. Today's US collapse initiated from 1161.75 pinnacle, where she retraced 38% of 1175.75->1152.75 earlier decline; why — I don't know…

3. Yesterday's closing bell terminated the unprecedented single-session rally 1112->1175.75 just short of 38% retracement of 1291.25->1112 seven-session drop; why — I don't know…

4. Yesterday's European slide 1154.5->1132 reversed up from 50% retracement of Asian 1112->1154.5 rally; why — I don't know…

5. That Asian rally reversed at 1154.5 = 38% of the preceding crash day 1221.25->1112 drop; why — I don't know…

6. The crash initiated after down-side reversal from 38% retracement rally of preceding Sep19->Sep24 decline 1291.25->1180.25; why — I don't know…

7. The 1291.25 limit-up pinnacle terminated record two-session rally 1136.25->1291.25 at 50% of EPZ entire summer's bear move 1443.5->1136.25; why — I don't know…

What's all this nonsense with E-mini futures?

And why did the two panic single-session Dec Bond rallies on Sep29 and Oct1 terminated at 62% of the way to preceding high? - I just don't know…

Sep

29

OK7, from Anatoly Veltman

September 29, 2008 | 21 Comments

A VeltmanA real-life anecdote: About two years ago I get a call from an acquaintance, running R&D for multi-billion blackbox. They were to enter the Commodity arena and he wanted a suggestion on a data-source. I said CQG. In spring of 2007, I notice CQG symbols BOK7 (Soybean Oil), COK7 (Cocoa) and OK7 (Oats) moving together day-in day-out. You pull three daily charts — and you think you’re looking at one! It turned out, their Brains initiated a major buy program based on the similarity of the data symbols!

Sep

28

A Veltman1/ Gold: our suspicions, based on decline in Open Interest, proved right. The jump $780 -> $891 was entirely on Spec short-covering, while Commercials liquidated longs. This is not the hallmark of flight-to-safety circa '79-'80. On the other side of the coin, Silver commitments relatively improved: Commercials unexpectedly covered some shorts during the jump $10.52 -> $13.17, while Specs covered some longs. Open interest gains in Platinum Group Metals (PGM) proved not of bullish make-up: Commercials duly shorted the rally. Note: both PGMs already slid nearly 10% in three days since the report!

2/ Nov Crude $15 mark-up occured, as Large Spec short-covered Oct Crude! Small Specs went Net new Short into Novee rally — making us much friendlier! Moreover, bullish C.O.T. divergence is uncovered in RBOB: Commercials became 10% more Net Long in course of 10% price rally! NG commitments improved a bit further: Large Specs notched yet another Short Open Interest record, while sentiment is bordering dramatically over-sold!

3/ CD and BP 4% rally didn't trigger Commercial selling; thus, we can expect more rally! Not as bullish in EU, SF, JY, AD.

4/ SP futures quarterly rollover showed plenty of Commercial short-covering, while Small Specs assumed new shorts — a recipe for a dramatic short-covering rally!

5/ Treasuries display dramatic Open Interest drop-off, a sign that little quality is perceived in traditional "flight-to-quality." Of note: the only willing shorts at the short-end remain Commercials; while Specs are bearish long-dated!

Sep

27

Dr PhilAll moving averages have to be based on a backward looking window of time. So a 10 day average is the average of the last 10 days and so on. But the center in time for that average is really about five days ago. To be more precise it is (n+1) / 2 days ago or 5.5 days ago.

So comparing two moving averages of different lengths is really comparing apples and oranges. If we compare a 10 day to a 30 day average, for example, then we are comparing the average of 5.5 days ago to 15.5 days. In other words they are not the same point in time. Mr. Glazier's enlightening 3D representation of moving averages of various lengths shows that the longer windows respond more slowly to ripples in price than do the shorter moving averages because of this lag effect.

Another feature visible in the chart is the apparently cyclical undulations. The problem with that is that it may simply be a manifestation of the Slutzky - Yule effect. Essentially Slutksy-Yule says that any series, when averaged, will show sinusoidal oscillations as a result of the averaging process. This is true even if the original series was composed of random numbers which could not possibly be sinusoidal in nature.

Another common pitfall when using moving averages is to think that all one has to do is to find the magic combination such as a 19, 27 and 79 day triple crossover with a minimum threshold of 1%. The problem with any such system is that there are an infinite number of these combinations. We quickly fall into the data mining trap where we will appear to find something even if it is merely a product of chance.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Yishen Kuik adds:

Another interesting point about moving averages is that the daily change in an N period moving average is caused by the difference between the values of the Nth day and the current day:

MA(t) = (1/N) * ( p(t) + p(t-1) + … + p(t-N+1) )

MA(t) - MA(t-1) = (1/N) * ( p(t) - p(t-N) )

So in cases where N is small, and where the p(t-N) value that fell out of the calculation is large, the moving average can experience sudden drops. This causes that cognitive dissonance when one sees a moving average fall even as the values are climbing between yesterday and today.This also provides the intuition to Slutzky Yule - for any given set of observations, there exists a cluster of points that has the highest average of all similar sized clusters, so while that cluster is passing through the calculation period of the moving average, there will be a peakedness, with two troughs surrounding it.

Alice Allen remarks:

While we’re talking about moving averages, a practical caution from my own experience with a popular commercial trading platform: If you are in a fast trading situation, monitoring a price graph with less than a 1-day display unit (e.g., 60-min, 30-min, 15-min), a line labeled “200-Day Moving Average Study” may not be the true 200-Day MA but perhaps the MA of the last 200 ticks. Under these circumstances, you may visually note that the price has crossed your MA line, but it will not necessarily be a true MA crossover as calculated by programs. Maybe this is obvious, but it took me a while to figure out and perhaps is unique to the platform I use.

Anatoly Veltman writes:

The best use of MAs that I know has nothing to do with crossovers. And it happens to be essential to one’s daily/weekly chart perspective. Extremely useful! I first saw it described by Stan Weinstein; then the periods and trading signals were optimized by a few proprietary shops. I believe it to be one of the better tools; if not for all markets, then at least for stocks.

Sep

23

A VeltmanCommitment of Traders (C.O.T.) report is always three days late; latest release 9/19 was as of 9/16 close. We had a few "events" 9/17-9/19, which didn't figure into the report Also, many futures contracts were expiring 9/19 — important caveat to mechanical users of positions data. Still, we tried and distilled a few hints…

1/ Stock Index C.O.T. were slightly Bearish: Commercials were adding Shorts on decline, while Small Specs bought near the lows — altogether indicative, that those were not likely final lows!

2/ Treasury futures lost Open Interest across the board, most pronounced was 30% loss in 2-year! While we don't have much of directional signal in Treasuries, my hunch is that players are trying to distance themselves from the Fed. Fed's competence and consistency has been questionable all year; now I'd venture say that even its credit-power has been undermined. If Fed can no longer pull punches, what's the use to even try forecasting its moves and speculating at short-end?

3/ Currency futures expirations more than halved Open Interest, leaving telling carcasses to behold: Commercial EU Longs 68k vs. 24k Shorts, BP 75k vs 12k, SF 22k vs 3k, AU 29 vs 10k! Those not appreciating these commitments near 78c AUD lows, please consider: near 98c AUD highs just 2 months earlier, Commercial commitments were Long 10k vs 70k Short!

4/ Metals Open Interest was the greatest surprise of 9/17-18 $777->$926 historic Gold jump, which awoke memories of 79'-80' flight to quality. The retest of $1000 appeared a given. Many began to verbally speculate on imminent move back to Gold Standard! But we see more talk than action: Gold Open Interest was supposed to baloon on 9/17-18 rally; instead it deflated by 2%! Silver's by 4% to new 2008 low, Copper's by 3% also to lows! Curiously, Platinum's and Palladium's did rise — Japanese prolifiration on dearer Yen?

5/ Energy futures lost Open Interest across the board, with Crude's hitting 2-year low! The biggest surprise was increased Commercial Short on collapse from $100->$90; while Small Specs covered Shorts! We were confident Long before we'd discoved all this; now we'll be itching to sell into rally

Sep

13

A Veltman

1/ Net Large Spec Short of over 170,000 NG futures; for every two Long fund positions there are 3+ Shorts now! Note: NatGas price nearly halved in just 2 months — talk about dedicated trendfollowing!
2/ Crude is now sporting Small Spec Net Short — Not a very bearish indicator; RBOB has had mostly Commercial Short — thus not prone to panicky cover on hurricane.
3/ Gold is not setting up for further liquidation, as Commercials have been buyers into decline; surprisingly, Silver is lacking same commitment — despite nearly halving its price in two months!
4/ Yen rally on crosses attracted duly Commercial selling; thus Yen is not likely to jump further!
5/ 30Y bond features aggressive Small Spec Short — prone to Short-cover; not much featured across all other Treasuries!
6/ Nasdaq Mini's drop was met with good Commercial bid; thus ENQ is better supported compared to other indexes.

Sep

12

A VeltmanWe have the long-anticipated the halt to currency straight-line meltdown, playing out since the July 15, 2008 EUR record of 1.6040 (one-sixty-forty). Curiously, its last bull-wave commenced at the Nov 15, 2005 low of 1.1640 (one-sixteen-forty)! It's easy to figure out: the 50% retracement mark is 1.3840 — and such will likely contain the current unprecedented-in-velocity correction. Remarkably, Sterling touched down Thursday near 1.7450 = 50% of the entire 2001 -> 2008 run from 1.3682 to 2.1160!

Aug

27

The most amazing thing about markets to me is that no matter how many previous instances I have, I can never find days that are anywhere near the ones we are currently having. The S&P is moving from x day highs to y day lows with impunity and alacrity and then hanging on the balance scale at the end of day when Zeus decides who will win.

Peter Earle replies:

I remember reading a book several years ago about Roger Bannister and his breaking of the four minute mile in 1954. At the time there were any number of physicians who predicted that the record was physically impossible to break; one predicted that Bannister's heart would explode in accomplishing such a feat.

I was reminded of this in both watching (and hearing) that, once again, in a seemingly inexorable march of highs (and lows), world records were broken throughout the Olympics in Beijing.

It bears mentioning that the events themselves have changed greatly from year to year: not only in the rise of professional Olympians, undistracted from a training (indeed, a living) regimen by employment, formal education or social duties, but as well in the structure of the events themselves. Engineered swimsuits, deeper pools, vacated end lanes, and other such changes in swimming events alone have contributed to the aforementioned increase of extremes.

So too, in the markets: that the year-over-year outdoing of previous records in extremes have as much, if not more, to do with the character, fragmentation and specialization of market venues; the "democratization" of access to various markets, bringing millions of additional opinions and hundreds of billions more dollars in; the rise of electronic, in particular algorithmic trading; better/faster processing speeds in technology; and the like, ad infinitum — than of any intrinsic quality of markets.

Kim Zussman ponders:

Like global warming, it is hard to measure whether the market becomes progressively and durably more efficient, or just temporarily stations in an efficient regime. Presumably the proportion of outperforming trader/investors who persist over long periods must go down if markets get more efficient, but that number ought to be hard to get, in that widespread knowledge could discourage the hopeful machine.

Anatoly Veltman adds:

I'll give you another factoid: TY (10-y Treasury futures) lost 10% of Open Interest on the Fri, Aug 22 drop. We just found out that FV (5-y Treasury futures) gained almost 10% of Open Interest in Tue, Aug 26 slow trade. Any connection to the recent abandonment of 10-y as the benchmark?

Aug

15

A VeltmanToday, I want to open the following idea for discussion: I noticed that Bond O.I. has diverged bearishly in recent days. (Definition is simple: O.I. is declining, while Price is moving into new highs.). I eyeballed a daily chart covering about 40 trading days, since June Bond left the board June 19th . It appears that on 75% of those 40 trading days the Price and the O.I. went either both up or both down! To flip this observation: on only 25% of the days the Price and O.I. diverged! What surprised me: Price since that date is 3%+ higher, while O.I. since then is 3%+ lower! (O.I. has now fallen to its lowest in almost a year!). Does that mean that one should fade current rally, once one gets Sell signal from one's other indicators? Note: I'm also intrigued by the fact of continuing bullish pattern of "O.I. down on down-days, up on up-days." How does one reconcile the two?

Christopher Tucker asks:

Shouldn't one fade any rally when one gets a sell signal from one's "other" indicators?

Nigel Davies extends:

GM NigelWe've this kind of issue with cycles. The parameters are intuitively obvious to the human mind but the very devil to explain in a way that a computer can understand.

There is the same problem on the chessboard, for example in understanding positional elements such as pawn structure. Humans are able to divine what is important in a position whilst the computer will assign the weights it was programmed to do even when these things are unimportant. The problem is that it cannot take a holistic view, it can only work on already disected parts.

Besides the Senator's book I think it's worth reading Dee Belveal on this. But once again it's not going to be something that lends itself readily to 'testing' via quant methods because the parameters are very difficult to define. I suggest instead that one adopts the approach chess masters use, and that is to play through all the games by hand in order to acquire a 'feel'.

BTW, I'm indebted to Anatoly for posting in the way that a games player can finally understand.

Manuel Bravochico adds:

I just got back from my monthly luncheon with my friend. He used to manage a restaurant before trading. About all he knows how to do on a computer is flip through charts looking for momentum. He amassed a small fortune and has compounded at the highest rate of return — although with some 50% drawdowns — that I’ve seen, north of 60% since 1999. Verified.

I keep asking him how he does it. He always gives me the same answer, “the chart just looks good.” He has a “general” set of rules that I have never been able to program over the years. At the elite level — Rentech excluded — most trading I think cannot be programmed, i.e. a holistic process unable in this age to be programmed.

Shmuel Layla writes:

The way I deal with false divergence signals that start occurring in the course of a Trend is not by looking at other confirming indicators, but rather by looking for the occurrence of a divergence on a higher time frame corresponding to a different set of peaks and valleys that has yet to resolve itself. I then find that the “local” divergence has more reliability. This is fractal trading for the mathematically challenged such as I. This works on volume charts of the ES contract. Maybe other issues with stronger trending properties require a more sophisticated solution. For the time being there is sufficient liquidity for me in the ES.

Rocky Humbert muses:

Anatoly’s post is indeed thought-provoking. It hits on many different issues. One approach might be to adjust position size to reflect confidence: i.e. you don’t have to go “all in” on every hand that you play. Certainly, this is how some gamblers might handle the problem.

Taking his question literally, however, I continue to argue that increasing open-interest reflects a coincident indicator of trend persistence, rather than an indicator of absolute direction. For an illustration of this phenomenon, look at the bond contract from March 2006 to May 2006 when the contract fell from 112 to 106 and the aggregate open interest increased from about 0.6m to 0.9m.

As the bond contract has been range-bound for the past year, this would be consistent with a declining open-interest. Of course there are other fundamental deleveraging explanations for declining open-interest too.

Anatoly Veltman responds:

Rocky, you picked a remarkable 2006 example! It really helps to understand one of your points: that the reason for currently stagnating O.I. is that bonds have been mired in a boring range (as opposed to the clear chart breakdown in spring of 2006). However, I will always take issue with outright scepticism about using O.I. to derive signals, at times. If not used properly, as in my own hand-picked current bond example, it sure may be of little use. But I know, and have utilized throughout my career, so many fantastic opportunities where I was able to make use of O.I. for prediction/confirmation.

Aug

6

A VIt was pointed out earlier in the week: S&P came up toward critical 1292.00 technical resistance. Now, with two sessions to go in the week the world is holding its collective breath, and everyone says: "the proof is in the pudding: will the breakout materialize?" SP futures were hit by onslaught of negative news overnight: AIG, European Central Banks, a jump in Oil on Turkey pipeline force majeure, Target, Jobless Claims.. down 15 handles! A fake-out of historic proportions?

In the meantime, each of the major European currencies has declined over 6% on straight-line three-week spiral. This put them within spitting distance of 2008 water-marks: 1.0622 USD/CHF, 1.9338 GBP/USD and 1.5305 on flagship EUR/USD!

So, as the starting pistols are about to go off in Bejing, the no less interesting games are about to unfold on global electronic arenas. Each of those contracts could potentially pace one another, and make the crowds scream!

Jul

25

A VeltmanA fascinating game is on today in Crude futures, with algorithmic black boxes sniffing out sell-stops below 121.61, which will mark a new low for summer 2008! Such a game would have not just short-term implications. Yes, it would be enticing to keep shorting until the stops are triggered, thus allowing a later profitable cover. But also, a long-term "chart damage" would be created once the first lower low is marked on this year's chart. The implication of that would play out some time in August when programs would then gear up to be "sellers on a rally," only because of this little "trend change" indication.

George Parkanyi suggests:

I don't know, Anatoly, that's reading in a lot. Even Freud once replied testily that "a cigar is sometimes just a cigar". But I'd love for your scenario to play out, so I can take another profit from my oil short position.

Anatoly Veltman explains:

CFTC's Commitment Of Traders (C.O.T.) report as of 7/22 settlement, published near Friday's close, confirmed our suspicions. For the first time this year, both Large and Small Specs rolled over from Net Long to Net Short in crude! The speculative push is on: to try and trigger sell-stops near $121.61 June low. One should be aware of fragility of such a plan: 1. Crude has fallen two weeks straight on reduced Open Interest (from 1.35m to 1.22m), i.e. over 100,000 Longs already got out and do not have a resting stop-loss order below. 2. Price has entered the area of natural support: 38.2% retracement of 2008 advance and 100-day moving average.

Thus, whether Specs succeed and trigger remaining sell-stops or not - the ensuing rush to resume buying activity should not keep us waiting for too long.

Rocky Humbert analyzes:

In my many years of commodity speculation, the most important lesson which I have learned is humility. The second most important lesson is to look beyond the obvious. And the third most important lesson is that price action leads the fundamental news. In this case, I suggest Anatoly look to all of Nat Gas, Coal, RBOB and Heating Oil crack spreads, and the shape of the yield curve, for far more interesting market information than whether a particular price point triggers some short term or long term stops.

  1. Nat Gas has given back its entire rally since January without so much as a minor bounce. This would equate to Crude moving to 90$/bbl without any meaningful bounce. Coal has also taken out the price equivalent of Anatoly's stop level on the downside.
  2. The gasoline (RBOB) crack spread has been negative or near zero for some weeks now. This is unprecendented for the summer driving season and shows the extent of true end user demand destruction. Refineries will obviously reduce their runs rather than process crude at a negative crack spread. Crude is a completely useless commodity. It's the products that really matter!
  3. The heating oil crack spread, in contrast, remains extraordinarily wide. Some attribute this to Chinese hoarding post snowstorm/earthquake and pre-Olympics. So the gasoline and heating oil crack spreads are giving us contradictory signals. While I'm open-minded on the outcome (although short right now), if I see the heating oil crack start declining, I'll know for sure that it's game, set and match for this phase of the crude bull market, and I'll aggressively press my shorts.
  4. The Crude yield curve recently moved to contango from backwardation. Producers are now motivated to build even more inventories, and this is a self-reinforcing feedback loop. When the crude curve goes into contango, it is predictive of declining prices in the spot contract for the following three to six months.
  5. The price volatility of crude is around 40% now. So, as a pure probability statement, one can easily envision a 40% decline from the "high" and we'd still be in a "secular" bull market! More importantly, given 40% volatility, one would expect daily swings of around $7 per barrel — just as random noise.
  6. I am unaware of any rigorously backtested studies which show that the COT open interest is predictive in crude. They are only a coincident indicator of trend. Perhaps Anatoly has different studies available that he can share?
  7. Lastly, and most importantly, many commodities do trend for good economic reasons. I suspect even Vic and Laurel will concede this point. One can ridicule the trendfollowers but I reckon the good ones have been long crude from $90 and started exiting when we broke through $135.

Right now the entire energy complex appears to be breaking down after a remarkable multi-month and multi year-bull market. If you are buying the dip for a quickie bounce — good luck! But if you hold your positions for weeks or months, as I do — it's frivolous to declare your entire market view based on whether one particular price prints. Markets are far wiser than that.

Anatoly Veltman replies:

Rocky, your observations are very useful. I'm glad to further discussion on short-to-intermediate term Oil - moreover, your view is coincident to Ahmedinajad's "unjustly over-priced!":

  1. What if NatGas next "bounced" big?
  2. Demand destruction and "importance" of only products — agreed.
  3. So short crude based on RBOB; not yet short a second unit based on HO?
  4. The "contango bear indicator" has been obvious throughout NYMEX history; has it been tested over the recent years, since Crude futures (and ETF based on them) became an asset class?
  5. My Elliott Wave log-scale chart allows correction to $50, before Wave 5 ensues.
  6. I am against C.O.T./O.I. techniques' mechanical application. Only a trader with sophisticated understanding of how it confirms/overrules a trading idea should use that coincidental data.
  7. $135 broke one up-trendline — agreed. What put you into a long over $90 through $147.27 — everyone could learn from a detailed explanation!

Rocky Humbert adds:

Anatoly, point by point: 

  1. And what if it didn’t? They call Natgas the “widow maker” for a reason!
  2. Glad we agree.
  3. Philosophically yes. But real life is rarely so easy.
  4. There’s only been one episode where CL swung from backwardation to contango since ETF’s came on the scene. That was Dec 2004 to Dec 2005. And although the nominal price went nowhere, longs lost money net of the roll cost. So, not enough data. But, putting on my bond hat for a second, positive carry really does matter.
  5. Cool. Then let’s stop chatting, you need to call your broker and go limit short.
  6. OK. I think the upstairs/offshore mkts plus the ETF’s have made these stats less useful. Also note that some people think that aggressively buying a heavily shorted STOCK is a way to squeeze shorts and make money. Other people believe that the shorts are smarter than the longs in individual stocks. In all events, I avoid using tools which are open to interpretation. I’m just not smart enough to figure them out.
  7. There are still Donchian systems out there. BUT …. even a blind squirrel sometimes finds a nut too. As a college math book might say, “the proof is left to the reader.” Hence you can decide whether it’s a blind squirrel or a useful system. Vic, Laurel and many readers of DailySpec are philosophically opposed to static systems … and I’d rather remain coy rather than risk being pilloried or laughed at. Let’s leave it at that please.

Mar

6

Many days recently when there was downward action, precipitated by derivative vehicles, there have been strong rallies to the close. Recalls youthful episodes of downward action, sounds of parental vehicles, followed by rallies to the clothes.

Anatoly Veltman adds:

If a month-long dollar decline has been all foreplay, can you imagine the multiple gasms in our assets about to come — not to mention households filled with crying nine months down the road.

Jan

6

NYMEXI read an amusing recount of that $100 oil trade in the paper the other day at the NYMEX. They said that it was a local trader that bid $100 for a one lot in the pit, and was immediately speared in the trade. The article further said that the local pitched his long position with a $0.60 loss. I was shocked to read that they were saying that this trade would be investigated by the NYMEX because the electronic trading (which trades most of the volume) was at a lower price and this local must have been engaging in some kind of market manipulation, wanted bragging rights, or whatever. The article then editorialized about how the electronic markets are so much more efficient, and that the open outcry method is destined to the dustbin of history. They might be right about the dustbin part, but the writers haven't a clue about locals and their purpose in the food chain. One of the jobs of a local, besides providing liquidity, is to see what price the market will trade. If wheat is trading at the top of the daily range, a local will bid the price up a quarter cent just to see what kind of orders might be up there. The local will also sell the market at a new low just to see what's down below. Good locals get a feel for where the stops might be, and try to steer the market toward the stops. In my experience as a local, I bought the top of the daily range and sold the bottom almost every day. In fact, if I didn't buy at the top and sell at the bottom, I felt I wasn't doing my job with 100% efficiency. Although I lost money on those trades, I made sure they were only one contract, and it usually cost me only $25 to see where the edges of the market were. To me, it was worth $50 a day, which is a small price to see the market range. Those losing trades represented good value to me, and the strategy of pushing the market in that manner was very profitable in the long run. In the 1980s, I sold one contract of oil at the NYMEX at the all time low, and didn't feel a bit stupid about it.

Victor Niederhoffer remarks:

Many exotic options might have been triggered at $100 in oil and the trade might have created massive fictitious losses or gains for interested parties.

Larry Williams offers:

Larry WilliamsJeff stikes a nerve with me on electronic vs open out cry.  I'd love to go back to open outcry or one session markets. If there were one session, electronic or pits, with defined time zones it would be a much easier game. Now, thanks the electronic wizadry we have three sessions; 1) the twilight zone after the pits close, no liqudity, lots of false moves — and lots of real moves, massive slippage; 2) volume picks up 1-3 hours before the pits, still erratic but trades better, a little less sloppage (I mean slippage); 3) the real deal hours, better fills, moves are for real.

Anatoly Veltman recounts:

In open outcry Gold futures trading at the Comex in 1989, my volume equaled 10% of the total exchange volume on quiet days — although I was not in the pit, and didn't own a seat at the time. Contrary to popular belief, floor brokers and locals were not raping every customer order going into the pit. Things got progressively worse, as seat prices skyrocketed at the start of this century; it eventually cost $1,000/day for floor rights alone, not to mention all kinds of overhead and error risks! And that's how demand destruction for floor trading took hold. Current electronic execution is much more disadvantageous, from where I stand. Black boxes at a handful of firms scan the exchange order books every millisecond and automatically execute algorithmic trades, ripping any conceivable advantage away from participating public. They are the casino, with structurally embedded multi-billion annual profits — leaving everyone else on the other side of the zero-sum game. Question is: what evolution event will lead to eventual demise of their empire?

Dec

20

CountingEverywhere I go, everywhere I turn, I am beset by people who believe this is the time to get out of the market because it looks bad. They have many reasons for feeling things are bad. The latest is a spate of forecasts based on inefficacies of the central banks, solar spots, and likely changes in pessimism. I would urge those who have given up the quantitative approach to come back to their roots, realizing the following:

 1. When the market looks bad, it is more bullish than when it looks good, e.g. after a series of down weeks.

 2. When there is a 10% a year drift, you have to overcome above a 1/2 point a day drift for each day that you're out of the market. If on average, you're out of the market for 60 days, while things look bad, that's 2% you're giving up.

 3. In order to time the market you have to find a time to sell and a time to get out. If you time it by getting out when the market moves X% below a Y day moving average, and get in on the reverse, you'll have the worst of all worlds quantitatively.

 4. When the market is down, of course the news is going to be bad. But is that good or bad for the future? I don't believe the news is worse now than it has been on other occasions where the market is down 5% in two weeks or so, and if it were worse, I don't know if that's bullish or bearish, except for what happens when such occasions occur without regard to any Monday morning quarterbacking.

 5. The forecasts by the big houses of up 10% to 15% based on the differential of the earnings yield and bond yield have been extraordinarily accurate on a prospective basis over the last 15 years as witnessed by the work of the Spec Duo and Mr. Downing on this front.

 6. If you return 14% a year for 10 years you'll end up with 2.5 times as much money as if you grow by 4% a year, and five times as much after 20 years, And that's the underlying compound interest factor that makes the differential return models work. That kind of difference is impossible to beat on a 20 years (or a one day) basis with consistent trading. Keep that in mind as you consider stocks versus bonds.

 7. Especially toward the end of the year, reversals are most prevalent and predictive, with work on individual stocks often showing that those down the most in the last quarter are up significant double digits in the first part of the next year. Is it time to get them now, or to wait until things look good?

 8. After years like 1907, which this year is so reminiscent of for some sectors, what happens the next year?

 9. When considering the hornet's net of worries that the stock market has been exposed to each year over the last 100 as we have documented on Daily Spec, are these troubles that much more significant? And if they are, have they been discounted, and what happens when troubles are more or less than usual relative to the market move? A quantitative approach here would be apt.

10. The market's been more volatile during the last two months in terms of ranges and big moves in an hour than ever before. Is that good or bad?

Before giving up the quantitative approach for a cyclical view of bull and bear markets and hoping that you can time them, I would encourage a little counting.

Alan Millhone remarks:

MoneyIn 2008 I will come into some money (not exactly sure how much) and plan on opening a growth fund for my two younger grandsons (ages 8 & 11). This is money I would not normally have on hand. I have been reading all the Daily Spec postings and learning about the Market Mistress. There is no better place in the world to live than America. Yes, this country has a lot of problems, but what country doesn't? If you have no faith in our economy then you need to crawl into a hole. American has always recovered and rebounded and opportunities will always abound for making money in the land of milk and honey. What other country can change Presidents and keep going strong without missing a beat? Victor's posting makes a lot of sense and is excellent food for thought. Currently bank CDs pay around 4.75% to 5%. There is a lot of turmoil at present and likely always will be. We all know that a new President won't be able to change all that much. So we forge ahead and work with the tools at hand. I am a dyed-in-the-wool optimist with respect to investing in America.

Anatoly Veltman extends:

GoldI am a die-hard value seeker myself and Victor makes a point dear to my heart. There is one caveat, that I feel is applicable to the current environment. We (more to the point: equity markets) have enjoyed the longest period in modern history, of (at least, we were told) subdued inflation. What if that changed? Then operating margins would suffer.

I got the hint that something is going amiss when my indicators on XAU, GDX, ABX, NEM all flipped into down-trend a week ago, while the same Gold Cash and Futures gauges remained in up-trend.

I scretched my head; then PPI and CPI came out and it dawned on me: traders in-the-know held on to the bullion, while getting rid of their ownership in operating concerns! And the Fed will have a job cut out for them, to reign in inflation's ugly head.

Now, since I feel a lot of the Gold Stock move has occured (gosh, GDX is down 21% in a month!), I'm trying to get short stocks that haven't fallen as much yet. Also, Gold should correct somewhat. And Platinum traded $1,529/oz record this morning, not far off my calculated $1,552 target — it should technically correct $300 for starters. Beyond that, I wouldn’t be surprised if it eventually dropped two-thirds of its current price.

Dec

19

1450, from James Sogi

December 19, 2007 | 3 Comments

1450A few months ago I counted how many times S&P crossed 1450. Yesterday adds two more. A few years ago I studied whether gaps tend to get filled as trader's lore has it. Not much there then. The large gaps in this regime are different than the typical small gaps of the past and today was a better example of trader's lore as the 11/28 gap got filled. It had been there nagging for weeks. Tests last year of round numbers were also inconclusive, and it's problematic defining the test. From my point of view, however, these two phenomena combined today in an elephant stampede in and out, effectively shaking out the last remaining shreds of hope of the prior night, and when the last hope was gone, allowing a huge rally back to the starting point. Typical of the market to scare the living daylights so violently only to end up near the start. I read recently that the NYSE specialists' job is to provide some sort of continuity in price and avoid huge gaps. With the Japanese, then the Germans, tag-teaming the US at night, and the ECB's jamming the thermostat full tilt, the bathtub is sloshing over. The recent average gap is over 10 points, as opposed to a normal mean of four. In the Logic of Failure, one of the side effects of this kind of out of control hysteresis creates is cynicism. In a contrarian way, that might be good. To give an example of this last point, "Contrarian" brings up 1.6 million Google hits. "Trend following" brings up over 6.6 million.

Anatoly Veltman remarks:

Talking contrarian: everyone believes the seasonal patterns favor a December rally, a January rally, or both. I was bullish and eager to exploit this tendency myself — until my trend indicators turned down 12/11. That includes SP, DJ, NQ, Russell, DJT; even Goldman Sachs (GS) and gold stocks (but not gold itself) fell into my down-trend designation last week. Only oil and utility stocks remained in up-trends; plus a few individual issues, like AAPL, MO, MCD. I'd venture and say, that the next crossing of 1450 to the down has a lot of potential to not retrace.

Dec

13

There is much talk about how to interpret the bearish Open Market Committee announcement followed by the bullish joint injection of reserves which led to the greatest absolute value of moves ever from 2:30 to close and close to open, 85 S&P points in total.

Many will try to interpret the content, the whys and wherefores of what was done, and the timing thereof, but I am tempted to cut to the chase and say that it is the like the final blast of the fireworks, or the finale of a classical symphony, or the final minutes of a sporting event such as a bike race or basketball game or 100 yard dash, where everything hangs on the last ultimate effort.

Rather than searching for more analogies, I will go out on a limb and say it appears to be the final disruptive move, the boiling water that the frog is thrown into to get him to jump, the greatest observable difference of Fechnerian Psychology. Merely the final attempt to loosen the weak from their positions.

There's the rub. Which side is trying to loosen which? I don't know. There have been seven days in the last 12 years where, like the last two days, there has been a high to low range of more than 45 points. The range Dec 11 was 56 points, and Dec 12 was 46. The last time it happened was Jan 3, 2001, where a 46 point range was preceded by an 81. Of the seven occasions, three were followed the next day by a rise, and four by a decline.

In closing I must tip my hat to the highest up open in futures in history (on a non-holiday), 34 points yesterday, surpassed only by the 36.5 on June 2, 2000 which followed a Memorial Day holiday, and surpassing the 32 point up open on the day after the Fed first lowered the discount rate this year (August 17, 2007).

Anatoly Veltman writes:

Bernanke & Co. managed to screw up a perfectly good market — and market participants will not forgive them! Tuesday: Fed fell prey to a technical set-up in bonds, that even many an experienced chartist didn't anticipate. Wednesday: they made an elementary timing error, much easier to avoid. I can't remember the Greenspan Fed erring on intra-day timing, except maybe in the first half-year of his tenure — when he could hardly fill Paul Volker's shoes in May 1987. All Bernanke needed to do: wait with the intervention announcement until well into the trading session — not release the golden goose a half-hour before the open! The result: we just completed two high-volume stock market sessions, both opening high and dropping all day! To add to the bearish sound of it: it's also happening during futures rollover — which enabled Wednesday's close well off the low, and right below the middle of two-day range. So, what do we have piled in electronic trading books for the remainder of the week? Offers on every stock right above the market — from participants let down by the Fed, and just praying for an up-tick — so they can get out, and call it a year. Well, those who pray instead of reason usually get carried out. The market will tire of knocking into their offers — and turn down. Will there be bids right below? Bid on new front month S&P 10.00 dearer than the one in front yesterday? There could be slight mental block about that — or am I the only guy in America loving stock specials?

Kim Zussman comments:

I am not knowledgeable enough to draw a constructive analogy between markets and nature.

A (popular type of) supernova is when a star runs short on hydrogen for fusion, cools and collapses, and in a huge explosion higher order fusion occurs, creating the heavy elements essential for the formation of life (as we understand it). Typing is complicated, as is the astrophysics, but in all cases it is a catastrophic explosion which would sterilize a large local sphere. Long ago I read that if the bright star Sirius, eight light-years away, were to supernova the radiation would end life here. (Our sun is too small for this, and supposedly in four billion years will run out of hydrogen and swell up as a red giant, engulfing earth. I am not too confident there will be sapient beings around then to worry about it).

Presumably the analogy is about how destructive supernovae are seeds of new life. In markets there seem to be periodic events which destroy longs, and shorts, and then maybe new life starts. The problem is they occur with day-week-month-year timescale, and only maybe you and three other people can see these in real time — the rest of us in retrospect.

Just isolating on human affairs, I can't imagine a real-estate decline compares with war, famine, epidemics, etc.

Dec

11

Handles
The bond move the last three days is down three full handles from 117 3/4 to 114 3/4. That's the greatest three day move down before a FOMC meeting in history, I believe (my data cover only the last 94 FOMC meetings from 1996). The closest contender was March 17, 2003 where a decline of 2 3/4 occurred. The bond market must not like price controls.

Anatoly Veltman writes:

Both the up-swing (to 12/4 118′22 high) and the down-swing (to 12/10 114′12 low) were on reduced Open Interest, allowing me to play reversals with greater impunity. O.I. tipped covering: it meant that fewer stop-loss orders have remained resting; a factor that substantially cushioned risk for the near-term value-picker. More interesting, both reversal trades were obvious to me in real-time; and the slight O.I. data lag was not hindrance.

The top was a double-top in price of the 10-year (and a secondary top in all Treasuries, from 2-30year); while O.I. displayed Bearish Divergence.

The ensuing chart decline was symmetrical to November's chart rally (the chart “symmetry play” piqued Victor’s interest on 12/4), and pointed to low-volume, thin chart space all the way down into the 114 handle. At the minute 114′12 traded, for 10 consecutive futures sessions O.I. cumulatively slid over 100,000 lots (10% of the exchange total)!

So, .25 on Fed Funds and .50 at the discount window — or any other combination, plus “all-important” Paragraph Three FOMC mumbling — the trade here is technically solid. My analysis is performed discretionarily in real-time; I suspect 21-century black boxes execute these trades quite ahead of me, unfortunately!

Carlos Nikros adds:

I suspect that lots of fixed income securities just became substantially longer in duration last week, as well, necessitating the usual hedging and pruning.

Andrea Ravano observes:

I think the fear factor that pushed bond prices to their limit is fading. If we consider yield moves instead of prices we get the following picture :

Mat./1week ago/Yesterday/Difference

2 Yr. 2.87 3.20 +0.33

5 Yr. 3.28 3.60 +0.32

10Yr 3.93 4.18 +0.25

The data along with the collapsing spread between Tips and vanilla Treasuries points to a "normalisation" of the bond market to pre-subprime panic levels.Which, of course, does not mean one should not be worrying about inflation in the long run, but short term wise, the move in bonds might be explained with year end book squaring and the end of the worst in the sell off of the stock autumn bear market move.

Alan Millhone remarks:

I wonder how many other UBS types will fall victim to the subprime debacle before the dust finally settles? May be a long and cold winter for builders/investors/developers. Investors look to the Feds to step in to stabilize. Fed intervention to me looks like a form of price controls, much like price freezes and rationing in the Second World War.

Victor Niederhoffer offers a postscript:

One can now see what the purpose of the four point drop in bonds in the previous three days before the Open Market meeting was: to vigilantly control the Governors from overly inflationary activities.

SP

Barry Gitarts adds:

The equity sell-off today at 2:15 was almost expected to happen as it did when the Fed cut rates last time. What's unexpected was that the market kept going down and did not stage a turnaround at 2:30 - 3:00 pm. Maybe it became too obvious and the daytraders with their one hole located at 4:00 pm got cornered. Maybe the market will resume its upward course tomorrow after feeding the big fish today.

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