COT and market sentiment

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A conversation early this morning with one member of the Indotraders.

Trader: kalau tidak sibuk, saya mau tanya sedikit Pak mengenai COT (Common Of Trader)
Trader: apa Pak Darma tau mengenai COT ?
Trader: COT itu mengenai apa Pak ?
Darma: Commitment of Traders ya
Trader: iya
Darma: posisi net open di bursa, mas ya?
Darma: di bursa futures
Trader: saya tidak tau Pak mengenai COT
Trader: mau tanya mengenai COT itu dan apakah bermanfaat bagi trading kita?
Darma: tergantung time frame kita mungkin pak. dulu saya pernah coba perhatikan, karena ada beberapa teman traders yg mencoba menginterpretasi COT menjadi sentimen market
Darma: tapi kok rasanya gambyar dan tidak ada korelasi dengan market ya. terutama dengan market di time frame intraday.
Trader: apa berarti hanya bermanfaat di time frame D1 ke atas ?
Darma: sedangkan untuk timeframe long term, arah market dalam ekspektasi 2-3 bulan ke depan, saya sendiri lebih suka menggunakan pendekatan sistem aja. misalnya dulu pernah coba dengan sistem turtle atau aberration. fundamental ternyata nggak dipedulikan samasekali oleh market.
Darma: COT mungkin bermanfaat untuk mengantisipasi sentimen market untuk market yang likuiditasnya rendah
Darma: misalnya untuk saham di bursa jakarta. posisi net open para partisipan akan sangat mempengaruhi harga.
Darma: tapi kalau di market yg besar seperti spot fx, kayaknya gak pengaruh samasekali. karena data COT yang ada di bursa di NY atau Chicago, itu hanya sampel kecil dari market yang jauh lebih besar.
Trader: ok, terima kasih Pak Darma
Darma: iya, mas. sama2. itu pun hanya pendapat saya mas. belum tentu benar juga kok.

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Tentang COT dari salah satu halaman di website CFTC:

Commitments of Traders

The Commitments of Traders (COT) reports provide a breakdown of each Tuesday’s open interest for market reports in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC.

Reports are available in both a short and long format. The short report shows open interest separately by reportable and nonreportable positions. For reportable positions, additional data is provided for commercial and non-commercial holdings, spreading, changes from the previous report, percents of open interest by category, and numbers of traders.

The long report, in addition to the information in the short report, groups the data by crop year, where appropriate, and shows the concentration of positions held by the largest four and eight traders.

Supplemental reports show aggregate futures and option positions of Noncommercial, Commercial, and Index Traders in 12 selected agricultural commodities.

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BIS report on volatility

Continuing my recent research on market volatility, i found this report from Bank for International Settlement (www.bis.org). The report can be downloaded from this link (pdf).

My observation on this change in market bahavior is confirmed in the report:

The evidence presented in this Report shows that over the period from mid-2004 to March 2006 the volatility of short-term and long-term interest rates, stocks, exchange rates and corporate spreads has been generally low relative to the previous five to 10 years in both industrial countries and emerging market economies (EMEs). However, if the sample period is extended back to the last two to three decades, for which daily data are available, other periods in which volatility reached similar low levels can be observed. The exception is represented by the volatility of short-term interest rates, which has reached its lowest level for 20 years in all the main currency areas.

Regarding the possible causes of this are:

The sharp decline of financial volatility witnessed over the last few years may have benefited from increased liquidity of financial markets. Since this concept is not easy to operationalise, it is useful to look at several indicators.
Throughout the sample the turnover of stock markets has increased considerably, and now stands almost everywhere around the highest levels since 1990. In the foreign exchange markets volumes were virtually flat over the period 2000-02, but since 2003 an upward trend has emerged.
In recent years financial innovation and the rise of new classes of financial institutions, combined with a change in the trading behaviour of traditional institutional investors, have contributed to increasing market liquidity.

And something more interesting is this part:

A key issue is whether the current low level of volatility is a permanent new feature of financial markets or only a temporary phenomenon. The results suggest that important drivers of the volatility reduction seem to be structural, and may therefore have a permanent effect on volatility.

So ? Less volatility. Smoother charts ? My quick guess is this: trend following strategy may perform better on lower timeframe.
Another good material was posted in my friend’s blog here, tittled “Market Effects of Hedge Funds”.

Short term vs long term systems

Dear friends..

I’ve came to a conclusion from several short term and long term systems that I know up to now.

Short term systems usually produce these outcomes:

1. Many small profits, usually consecutively. They may come as frequent as 70-80%.
2. A big losing trade will come occasionally, causing drawdowns. This is seldom, but alwas come and never can be predicted. Its just the nature of the system. This may as frequent as 20-30%.
3. Equity curve profile looks like this red lines in the picture at the bottom of this post.

Meanwhile, long term trendfollowing systems have the opposite profile:

1. Small losing trades usually happen regularly and consecutively. They are 60-70% of the total statistics. These are when cuting small losses.
2. Big profit comes when the system ride trends. They are seldom. And hardly are consecutively. We can not predict when it’ll come, but it is promised by the nature of the market.
   
3. The equity curve profile looks like the blue lines in the picture below.

Short term systems includes the bolltrade, the multilot systems, the short term breakout systems, etc.

Long term systems includes the turtles, the aberration, and several others.

They all pretty consistent with those profile I mentioned.
Any other system developers here observe the same situation ?

Rgrds,

Darma

(*)

The Secret to Making Profits from the Big Moves

Nice reading. Post this here to find them easier, just in case the original page is removed.

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The Secret to Making Profits from the Big Moves

In FOREX trading, it’s a fact that many traders simply can’t let their profits run – they enter trades correctly, but only ever, bank marginal profits.

“Let your profits run” is accepted market wisdom – but how do you do it in practice? How do you maximize your profits?

Many FOREX traders get in on a good opportunity, and take a marginal profit, or are stopped out – they then watch in frustration as the trade piles up $20,000, $50,000, or more – and they’re not in the market! This happens all the time, so lets look at how you can let your FOREX trading profits run.

Statistical Significance

When FOREX Trading, letting your profits run, is the only way you can cover the cost of your losses – and most traders don’t understand its significance.

What constitutes a large winner in FOREX trading? – You need to make ten times or more than your average losing trade. If you lose $500, you need to make $5000 – but how do you do this?

The only way to make money in FOREX trading is by letting your profits run – and this isn’t as easy as it sounds. You need to let your profits run with a NO profit objective. Of course, this is hard to do – and most traders don’t do it (and that’s why they lose).

There are two reasons why traders lose money in the FOREX market – one’s mental, and the other’s physical:

A Mental Dilemma

Why is it so hard to hold on to winning trades?

The emotion of fear comes into play here – the bigger the profit becomes, the more a trader wants to take it – before they lose it.

Watching a trade you are making money in, dip back is hard. Most traders simply say, any profit is better than no profit – so they take a small profit and feel happy. However, the profit isn’t big enough – and their losing trades wipe them out sooner or later.

Traders want to snatch ANY profit – in case it gets away – but this is totally wrong.

Physical Reality

The large trends simply do not come around that often.

By using an open profit objective, and a lagging exit, most of your FOREX trades will lose you money.

Trying to avoid losses by snatching profits, or running stops to close, will see you lose money in the long run, when you trade the FOREX markets.

The huge trends don’t come that often – so you need to catch them.

If you want to catch the big winners, then you need to see the majority of the trades that you enter, that are in profit, reverse – and stop you out at a loss

Because FOREX Trading offers traders fantastic long-term trends – that go on for months, or years – if you can get in on them, and hold them – you’re all set for huge profits.

Use Lagging Exits

A lagging exit is where you wait for confirmation of a trend change – before banking your profit.

Many traders try to anticipate a trend change – only to take profits early, and miss the major move – don’t fall into this trap!

Here are two exit strategies that will keep you in the trend for as long possible:

1. To exit a trade, use the 40-day moving average. If positioned long in an up trend – wait for a close below this level – and exit the position. In a downtrend, exit a short on a close above this level.

2. If long from a new 20 day high – hold position until prices make a new 10-day price low. If short from a 4 week low – hold short until prices make a new 10-day high.

These two lagging exit strategies will ensure that you are in the big trending moves, for as long as possible. In FOREX Trading, if you want to run the big winners, then you must use a lagging exit. If you do this, then you will stay with the big moves – and pile up huge gains – rather that get stopped out early.

Goldman Sachs Research: Fundamentally Bad

Following my previous post titled inside Goldman Sachs, here is an interesting article taken from covel’s site. Note the interesting part at the end of the article.

Goldman Sachs Research: Fundamentally Bad

Here’s the bad news: Not all TurtleTrader readers receive Goldman Sach’s daily research. Now here’s the good news: The ones who don’t aren’t missing anything. TurtleTrader is not a client of Goldman’s nor do we endorse them in any way. We just happen to be on the mailing list. Okay. So now we’ve dispensed with the disclaimers.

Goldman daily research is extremely detailed. Projections abound. Discounted cash flow valuations, balance sheets and income statements overwhelm. It’s all there — the market performers, trading buy recommended lists, etc. as well as Goldman analysis. Tons of information right? Yes, indeed, but mostly useless.

For example, let’s take a look at PlanetRX, the online drugstore. Goldman has been promoting this baby as a great buy since shares sunk from the mid-teens to its most recent value of $2 a share. All of Goldman’s promotional analysis is based on its research minutia involving fundamental factors. None of the analysis is based on what the stock is actually doing, which is tanking. If the analysis was based on what the shares of PlanetRX were actually doing, any successful trader would know you would sell, not buy.

Why do large, respected brokerages go through the time and effort to produce such useless drivel by large salaried fat cat analysts? When you are a broker who earns monster fees and big commissions off pushing stocks and underwriting IPOs, you better make the package pretty don’t you think? How does this packaged information help someone who actually trades or invests? It doesn’t.

We would like to know how much of Goldman Sachs’ proprietary trading capital is actually invested as Goldman’s research suggests. It would be difficult, even for a Goldman Sachs investor, since the research never gives the reader solid advice regarding price levels at which to buy or sell. If the truth be told, we believe that Goldman’s trading capital is well positioned with hedge funds and trading firms worldwide that, as you might guess, trade trend following models.

ST vs LT trading

One member of the tradingblox forum, Mr. Cyphrograph (from Poland), brought this topic to the forum

Short term VS Long term trading.

Hello everyone. I guess I’m 3rd member from Poland on this forum, together with TK and steady_jake. We had some hot discussion on a polish futures message board, and now I want to continue it at “Trader’s Roundtable” as I believe it is more suitable for that kind of discussion. Here’s the hypothesis: Short term trading can reach the level of robustness (or performance), which can not be achieved by long term methods or long term trend-following systems or – let’s be straight – Original Turtle System. The question I want to ask you is: can we verify the above hypothesis using historical results (hypothetical from backtesing or actual trading figures)? IMHO, Yes we can do it. Since our abilities to predict future are weak, what else do we have beside history? Well-known method used for predicting possible outcomes, namely Monte Carlo Simulation is based on historical figures also.

I want to present a little research I’ve done on this subject. Let’s compare actual trading performance. Turtles vs Active Traders battle. We take 3 famous Turtles on one side (B. Dunn, J.W. Henry, W. Eckhardt) and 3 quants who employ short-term trading methods on the other (T. Crabel, Denali, C-View Limited). Let’s take 2 ratios for measuring robustness / risk-adjusted return / performance quality (name it like you want):

1. Compounded Annual Return / Worst Drawdown (CAR/WDD, monthly basis) – before management and incentive fees,
2. Annualized Sharpe.

Turtles camp:
DUNN Capital Management-DUNN WMA (Nov 84 – Sep 03)
CAR/WDD 0.52, Sharpe 0.64

John W Henry & Company-Financial and Metals (Oct 84 – Aug 03)
CAR/WDD 0.91, Sharpe 0.83

Eckhardt Trading Standard (Jan 87 – Sep 03)
CAR/WDD 1.38, Sharpe 0.75

Active Traders camp:
Crabel Cap. Mgmt-Diversified 1XL (Jan 92 – Sep 03)
CAR/WDD 3.77, Sharpe 1.38

Denali Asset Management-Ascent (May 99 – Sep 03)
CAR/WDD 10.26, Sharpe 2.75

C-View Limited 3XL (Oct 96 – Aug 03)
CAR/WDD 5.62, Sharpe 1.66

Source: www.iasg.com
Disclaimer: I’m not connected with any managers mentioned above.

Well, numbers speak for themselves As you may suspect, figures for short term systems backtested and optimized against the past data are much, much better – especially, when you set worst drawdown figure to around 40% by position size management rules.

Turtles camp has one advantage over active traders: they have longer track records. However, I don’t want to wait 15 years in order to have comparable periods. That is the zillion dollar question: will these excellent CAR/WDD & Sharpe figures sustain in the future?

Where are the grounds for differences between short and long term trading performance? IMO, they’re located in 3 main areas:

1. Math
Higher frequency of trades enables increasing positions size faster in a given period of time (compounding) during run-ups, but also enables decreasing positions size faster during drawdowns.

2. Source of profits
Long term trend-following / Turtle System captures profits from existence of trends (trends often connected with macro-economic cycles). As we all know, markets tend to move in trends but also experience long “choppy” periods, without any substantial move in one direction. Hence diversification is used to reduce negative impacts of non-trending periods in a single markets. Unfortunately, most liquid markets are highly correlated. As a result, these strategies performance depend on the magnitude of trends.

Short term trading captures profits from market inefficiencies, more precisely – from market’s over-reactions. If we’ll sum up all inefficiencies in the short-term level, they’ll add up to a greater amount than in the long-term level. Of course in order to play on short-term basis we must have low commissions and high liquidity – two things which have dramatically improved since ’90s or ’80s.

3. Predictability
Volatility in the coming short-term periods is more predictable than in the long-term periods. Try to estimate the average daily range for the next 5 days. Now try to predict the average yearly range for the next 5 years – error will be much bigger.