Subscriber's Guide

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Bullish Review's primary mission is to provide timely in-depth analysis of the Commitment of Traders in Commodity Futures report published by the Commodity Futures Trading Commission. This report has been published since the 1970's but was discontinued in 1982. Due to public pressure, the Commitments were restarted in 1983. I refer to the post-1983 reports as modern data. Pre-1982 data is of little use in our analysis due to two factors: (1) Reporting requirements and collection procedures were substantially changed in 1983; and (2) the Large Speculator category is dominated today by commodity funds which were an insignificant factor prior to the 1980s.

The Commitments report breaks down the open interest in major futures markets into 3 categories. Large traders (who hold positions above reporting levels established by the CFTC) are required to report their holdings on a daily basis. Their positions in most cases are actually relayed electronically by their broker. These positions are broken down into Commercial and Non-commercial (Large Speculator) categories. The balance of the open interest is listed as Nonreportable positions. This includes both speculators and commercial hedgers whose holdings are below reporting guidelines. We refer to these as Small Traders.

SAMPLE Commitments of Traders Report

HDR3140100001000107941530 IMM S&P 500 STK INDX     01/04/94 
                    REPORTABLE POSITIONS                     :
-------------------------------------------------------------:  NONREPORTABLE 
      NON-COMMERCIAL      :   COMMERCIAL   :       TOTAL     :    POSITIONS 
--------------------------:----------------:-----------------:----------------
 LONG  :  SHORT :SPREADING: LONG  :  SHORT :  LONG  :  SHORT :  LONG  : SHORT 
------------------------------------------------------------------------------
(S&P 500 INDEX X $500.00)                             OPEN INTEREST:   183,638
COMMITMENTS 
  5,824   22,228    1,217  136,901  122,906  143,942  146,351   39,696  37,287
  
CHANGES FROM 12/28/93 (CHANGE IN OPEN INTEREST:  -1,592)
    -26    3,500      350   -3,518   -4,415   -3,194     -565    1,602  -1,027
  
PERCENT OF OPEN INTEREST FOR EACH CATEGORY OF TRADERS 
    3.2     12.1      0.7     74.5     66.9     78.4     79.7     21.6    20.3
  
NUMBER OF TRADERS IN EACH CATEGORY (TOTAL TRADERS:     165) 
     10       24        3       92       77      105      101 

CoT Index Calculation

This index converts the net positions to a 0 to 100% bullish scale based on the relationship of the current Commercial net position to historical extremes. The formula is as follows:

Traders familiar with Williams' %R and Lane's %K will recognize the similarity in the COT Index formula. The same algorithm can be used to calculate an Index for the Large Speculator and Small Trader categories. In these instances the net position of the individual group (only) is considered.

Accurate Data?

The CFTC currently tabulates net positions each Tuesday and transmits the Commitments report for futures only every other Friday afternoon. We collect this data and update the CoT Indexes, Download Files, and Jave(tm) Charts on Friday night. The futures plus options report is transmitted the following Monday afternoon. The Bullish Review is normally updated on Monday after we have had a chance to review the futures + options data. Fax transmittals are made after 11:00 pm Eastern US time and mail subscriptions are posted on Tuesday. Obviously, the Internet is the quickest delivery option.

The Commitments report was, until November 1990, issued on a monthly basis about two weeks after the end of the month. It had been largely ignored by individual futures traders due to the perceived untimeliness of the statistics. Thanks primarily to a letter writing campaign by our subscribers, the CFTC began twice a month reporting in 1990. Indexes for the period Nov 1990 to Oct 1992 are based on positions as of the 15th and the last trading day of each month. At the time of this change, the CFTC released bimonthly historical figures for the period of 1986 - 1990. These have been picked up and resold by some opportunistic vendors. What they do not tell you is that the historical data is unaudited and the CFTC acknowledges that it is unreliable with the following warning:

"Please be advised that prior to September 30, 1992 only mid-month and month-end data are available. Since the mid-month data were not published on a current basis, they may contain identifiable data errors. A substantial period of time elapsed between the report date for these data and their eventual compilation. As a result it is not possible to correct the errors." .

Our data base extends back to the beginning of the modern data, January, 1983. It took us 1-1/2 years to obtain the entire series from original reports. The CFTC does not even maintain data back that far. We painstakingly assembled and error-checked this data and believe it to be the most reliable and extensive data base in existence. Beginning in November 1991, the CFTC moved to weekly tabulation and biweekly release.

Bullish Review Format

The last page of each Bullish Review displays a tabular listing of the COT Indexes by trader group. This report is posted separately on the WWW on alternate Friday evenings, following release of the futures only data by the CFTD. Two indexes are reported for each group. These are based on positions from the past 2 Tuesdays. The date of the actual position tabulation is shown at the top of the respective column. Our primary interest are the Commercial figures shown on the left. The Movement Index is simply the number of points the COT Index has moved since our last report (2 weeks ago). A plus [+] or minus [-] next to the market name indicates a market where the Commercial COT Index has moved + or - 40 points within the past 6 weeks. We call this a minor signal. A double sign [++ or --] indicates a Commercial COT Index above 90% or below 5% respectively. We call this a major COT signal. The right hand column ("Last Comment") lists the most recent issue number in which we analyzed the respective market in the "Commentary" section which is 1 to 3 pages long (depending on market situations).

Crowd Psychology

Every year one or more futures markets makes an extreme price run--usually both up and down. Limit moves may occur for days on end until prices are far above or below rational pricing. This is crowd psychology at work. Crowd theory is a critical element in futures trading. As soon as you take a trading position you become part of a crowd -- ready or not. Traders' opinions become colored by the thoughts of the crowd. Conveniently commodity crowds tend to form along lines similar to the trader breakdown provided by the CFTC.

Commercial Hedgers are members of one of 2 crowds: producers or consumers. They trade on inside information and generally only in one direction. Producers (mining companies, mutual funds, grain elevators) hold a cash position in the commodity and sell forward in the futures market when they expect a price decline. Consumer commercials (food producers, manufacturers) have a future requirement for the respective product and buy forward in the futures markets to cover those needs. These two crowds use the futures markets to reduce risk. Besides a similar goal, these traders share an edge in fundamental supply and demand information and have the deep pockets and long term outlook necessary to trade on fundamentals.

Large Speculators are willing to assume risk from commercials in the exchange for profit opportunity. Some trading books written in the 1970s recommended trading with this crowd because they typically became large traders on the strength of their trading ability. Today this category is dominated by commodity funds who prosper in large part on their sales ability. Besides a shared competitive profit incentive, this crowd is dominated by computer driven trend following approaches that respond similarly to price movements.

The remaining traders include both speculators and small commercial hedgers. These Small Traders, by definition, have smaller pocket books than the other two crowds. Lacking inside information, this crowd is more susceptible to news, hopes and whims. Members of this crowd are likely to be bullish if long rather than long because they are bullish. An interesting characteristic of crowd psychology is that most members relegate decisions to the crowd and crowds often make decisions that their individual members would find illogical if separated from the crowd.

Futures prices react to buying and selling pressure generated by the above crowds. The crowd mentality causes price trends to move to extremes. It is those extremes that we hope to spot using Commitments analysis.

Open Interest Analysis

The Commitments of Traders report provides the only factual breakdown of open interest available. In other words you do not need to rely on pit rumors like "Saloman is selling bonds" or "Continental was a major buyer in beans today" to know what crowd you are trading with or against. Open Interest analysis is used to quantify crowd psychology in futures markets. Open Interest is defined as the total number of outstanding contracts in a futures market. Each contract is held by two traders, one long and one short. Trading textbooks have proffered certain maxims of open interest and volume (number of contracts changing hands over a specified period) analysis. These are usually stated as:

These rules are often repeated, widely accepted, and work--about 1/2 the time. Bullish Review attempts to determine when the open interest rules are likely to work and when they are likely to fail. First, we need to throw some cold water on the subject. Namely, from our perspective, volume is useless as a price predictor. Volume falls into the class of coincident indicators. That is, it holds no predictive value.

Volume Is Coincident To Volatility. On this T-Bond chart the 5 day average volume is graphed on the lower histogram. The 5 day average daily range (volatility) is inverted on the upper histogram. Notice the mirror image, as volatility grows, volume rises and as volatility subsides, volume declines.

Open interest analysis, on the other had can provide some meaningful predictive value. First a splash of cold water. In addition to those listed at left (above), another oft repeated rule states that an open interest increase during a consolidation is bearish because commercial hedgers are adding to their shorts.

Open interest rise during consolidation turns out to be Commercial buying: During the December's tight trading range open interest increased 27%. Textbook analysts viewed this as bearish. But reviewing the Net Trader Position chart you could see that Commercials were buying -- a bullish sign. When Rising OI during a rally is bearish: Open interest rose 35% during the strong February and March price rally. Textbook analysts saw this as a confirmation of the uptrend. Commitments analysts noted that Commercials were adding shorts on the rise and prepared for a correction.

The point is: why guess who's buying and who's selling when the CFTC is kind enough to provide a factual accounting every two weeks? We use open interest analysis between Commitments releases to alert us to a potential change in net positions. A change in open interest of 10% or more is enough to sound the alarm. There is no method available to determine the actual effect until the next report. Guessing has not proved any more reliable than the textbook methods sited. A substantial open interest change alerts the analyst that something in the mix of buyers and sellers may have changed. Some increased caution is warranted with any open positions for the few days until the next report.

Since it takes an additional long plus and added short player to create an increase in open interest, an increase tells us that crowds are expanding on both sides of the market. Expect higher volatility (and volume). Expect just the opposite from a decline in open interest.

C.O.T. Index Signals

The COT Index aids open interest and Commitments analysis by converting the raw net positions to a standard scale. Due to differing mixes of traders, raw net position charts cannot be compared between markets. The patterns can be completely different yet provide a similar forecast. We use the COT Index first to select among three dozen markets, those which appear to merit further analysis. Within a selected market, we use the Index to highlight prior similar patterns.

We have found there are two circumstances that signal special interest. We refer to these as COT buy and sell signals but you should not take this as a recommendation to buy or sell. We use these terms only to provide a clear indication of Commercial activity. You must employ your own system or methods to produce actual trade entry and exit points. We are looking for intermediate to major market turning points. These are special situations that may not be apparent from any other analysis but may take some time to develop. However, you cannot rely on the Commitments data to predict each major turn. This type of analysis is useful to both long and short term traders but your use of the information will be unique to your own situation.

First, we look for markets that are near the scale extremes. Below 5% for a sell signal and above 90% for a buy signal. We refer to these as major signals. Secondly, any market that experiences a move in the COT Index of + or - 40 points within the last 6 weeks generates a minor signal. A plus 40 movement is a buy and a minus 40 movement is a sell signal. The major and minor designations do not signify the degree of expected trend change nor the potential for the next move. Major just means that trading crowds are at historic extreme levels, differentiating from the minor signals which indicate a meaningful change in net trader positions. Either signal can be equally significant. When one of these signals are generated we expect a trend change. This can be from up or down to sideways or from sideways to up or down. The signal may also highlight a full trend reversal situation. Again, while these signals frequently highlight important trend changes when they occur, you cannot rely on Commitments data to warn you of every trend reversal. That would make it too easy.

SIGNAL FAILURES

In his book A Complete Guide To The Futures Markets, Jack Schwager highlights the most important rule of chart analysis:

"A failed signal is among the most reliable of all chart signals. When a market fails to follow through in the direction of a chart signal, it very strongly suggests the possibility of a significant move in the opposite direction.

. . .

"A novice trader will ignore a failed signal, riding his position into a large loss while hoping for the best. The more experienced trader, having learned the importance of money management, will exit quickly once it is apparent that he has made a bad trade. However, the truly skilled trader will be able to do a 180-degree turn, reversing his position at a loss if market behavior points to such a course of action."

C.O.T. signals should be treated similarly. We pay particular attention to the price level at which extreme COT readings are generated. Commercial hedgers will often defend the same price level each time it is touched for extended periods of time. Since Commitments figures are tabulated at each Tuesday's close, we can often identify exact price levels of Commercial operations. When prices break through a price level that Commercials have defended repeatedly, a signal failure is apparent. This type of move, by definition, is speculative driven and can be highly explosive (and profitable if properly played).

FUNDAMENTALS

I have received countless phone calls over the years, inquiring how Commercial traders could be selling (or buying) at a time when they were "obviously" trading against the fundamentals. That always reminds me of a comparison between statistics and bikinis. Both reveal much that is interesting but conceal everything that is critical. Some technicians believe that market fundamentals are already factored into the market price--therefore not worth study. I am not of that school. However, the same Commercial houses we are trading against just happen to be the primary source of fundamental news, forecasts and analysis. In the best case, by the time we hear the news Commercials have already acted on it. In the worst case, the news as disseminated is not factual or complete. Other sources of fundamental information sources include government reports that are notoriously inaccurate and the financial pages. Newspapers writers in general don't stick out their necks, are not well informed and don't like to look foolish. Therefore, once a trend is well established (or more likely nearly complete) they drag up every fact or rumor in the files that support what has already occurred. Moral: check your source.

There is no question that Commercials trade on inside information. It may be perfectly legal but it gives them an undeniable edge. We use the Commitments data to decipher true fundamentals by watching what Commercials do in the market (rather than what they say to the press). We have found repeatedly and regularly that Commercials accumulate (or distribute) positions and markets move well before the fundamental explanation is apparent. We use the COT Indexes as our primary source of fundamental information.

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