But the Media Said Differently
But the Media Said Differently
There is a dilemma that traders who make their trading decisions off of the news have been facing on a regular basis recently. Have you ever noticed that when the stock market is up in the morning, that the media "always" has good news to report? How about when the market is down in the morning? What type of news do you think you will hear then? Trading off the news will always make you late entering a trade. There are trading firms with a lot more money than any of us will ever see and they somehow have the resources and contacts to get this information (news) long before the rest of us. By the time you see "Breaking News" on your TV, you can bet that news is way too late to react on.
I would like to show you a way that we can coattail the smart money in the markets. This is not a timing tool nor does it tell you exactly where to buy or sell. What it does do is let you know when the "really smart" money is buying or selling. Then it is up to us to find a good supply/demand level along with good risk management to take the trade. By knowing what the smart money is doing, we will no longer have to listen to the media to tell us if the market is going to go up or down after the fact. Instead, we will know ahead of the media that a potential market move could possibly occur.
One of the many benefits of trading Futures is that once a week (Fridays), a report from the Commodity Futures Trading Commission (CFTC) is released showing us who is buying and selling in the Futures markets. The information is free and is available to everybody. The website CFTC has more details about obtaining this information. If you have TradeStation, I will show you how to see the information on your charts. You will need to have data coming from the exchange where the product trades to get this information.
The smart money I was referring to is not your large investment firms, managed money or broker. Smart money in the Futures industry is known as Commercial traders. These are the participants that we want to track and be trading on their side, long or short. Commercial traders use these Commodities everyday in their line of business. Therefore, they know everything there is to know about the product. They are aware of the seasonal/cyclical nature, extreme high and low prices, true supply/demand of the Commodity, weather conditions affecting the product, labor issues affecting production, or transportation of the Commodity, and the list goes on.
On the other side of smart money (Commercials) is usually what is known as dumb money (Small Speculators). I will show you how we can track them and find out if they are really being dumb by betting aggressively against smart money.
Let's first go through and set up this study on your TradeStation platform.
- Open a Weekly chart of a Commodity Futures contract. Do not use continuous contracts. For example, use SBH12, ECH12, TYZ11, etc.
- Right click on chart and find "Insert Analysis Technique"
- A menu will appear and you will now scroll down to and click on "COT Net Position"
- Once you do this, you will have the COT indicator at the bottom of your chart with 3 different colored lines. We will be using the blue and the red line. Disregard the green line.
- On your weekly chart, set your screen to only show the last 12 months of candles. For example, just show November 2011 back to November 2010
Now you have information on your screen about tomorrow's price action today. Figure 1 will illustrate what your chart should look like if you have a weekly chart of the Ten Year Treasury (TYZ11). I have removed the green line in the COT indicator by changing the color to white in the "Format Strategy" box. You will also see that my data points on the lower axis are just the last 12 months; this is important.
Figure 1
The COT Net Position indicator measures the difference of long positions minus short positions of each different category. These categories are:
- Commercial ñ blue line
- Large Traders ñ green line
- Non-Reportable - red line
We will focus on the Commercial and Non-Reportable traders for this article.
Commercial traders make up a very large percentage of the daily open interest (positions held overnight beyond the day sessions) in the markets. They usually have virtually limitless credit lines with banks and lots of cash to manage their positions. They also have no position limits like us speculators, so they can buy or sell as much as they need or want.
By using the COT Net Position study, we can track when the Commercials are the most bullish or bearish over the last 12 months. You will notice a black line running through the middle of the indicator. This is simply a zero line. If the red or blue lines are above it, this means bullish, or buying. If the red or blue lines are below it, then this is bearish. That is how most people observe this study. I like to take it a step further and look to see just how bullish or bearish they have been over the past 12 months.
To do this, we will look and see where the current Net Position is in relation to anytime over the last 12 months. If you see the Commercials line making new 12 month highs, this is very bullish. If you see them making new 12 month lows, then this is very bearish. Another thing to look for is to see if the dumb money (red line) is doing the opposite of what the Commercials are doing - meaning is the red line making new 12 month highs while the blue line is making new 12 month lows? This is a sign that undercapitalized traders are betting against the large Commercial traders and this is usually a losing proposition for them.
Figure 2 is the Euro currency chart. Look at the blue line when the market was making a significant low in October (up green arrow). The Commercials were buying more Euros than at any other time during the past 12 months at this low - very bullish. Notice the red line (dumb money) is showing that undercapitalized and novice traders are selling more than at any other time in the last 12 months, again bullish because they are betting against the smart money at an extreme COT Net Position reading. Notice the far right COT Net Position lines for the Commercials and Non-Reportable traders. Do you think this may have helped the Euro rally so strongly at the time of this writing on November 30, 2011? Looking at this weekly chart, we can see a nice weekly demand level with price returning to it while the Commercials were heavily long and the dumb money was selling into weekly demand. Wonder how they got that name?
Figure 2
Let's look at Crude Oil - a very similar pattern had immerged in October also. Figure 3 will show the Crude Oil contract being accumulated by the Commercial traders (green arrow) while the dumb money (red arrow) bet against them again.
Figure 3
These setups obviously don't come around every week, but you can go through your charts on weekends rather quickly and get an idea if there are any markets that are ready for a big move. Once you identify these setups, you will then apply your strategy to time your entry for the trade.
"Don't wish it was easier, wish you were better." Jim Rohn
Follow the smart money - Don Dawson
About Don Dawson
Don has been trading the futures markets for 20 years. His perseverance through the ups and downs of trading, openness to experience of others, balanced tolerance for risk and patience to wait for his setups are a few of his strengths as a trader. He is excited about sharing his passion for trading with others. A quote he likes is "A candle loses nothing by lighting another candle." He is now looking for a balance in life between trading and teaching others what he has learned from 20 years of trading. He acknowledges that the best teacher is a student ñ always in learning mode and wanting to learn more by teaching. He looks forward to working with each of you in one of his E-mini Futures classes. He is also writing articles for Online Trading Academy's free newsletter "Lessons From the Pros" and hopes students find this a valuable resource.
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