Hi Larry, I'm still loving the Smart Money Report - keep up the good work!

In the latest report (8th June) you note that the commercials seem to have timed the latest bull move very accurately, whilst they went short in May 2000 but the market waited until September 2000 before collapsing. Might this be an effect of the way market bottoms tend to consist of a sharp drop and bounce, whereas tops tend to be a slow roll over? I have not looked at previous bull/bear signals from the COT - have you noticed any differance in timing between bull and bear signals?

Thanks and best wishes, Nic

Hmm… you make an interesting point, Nic. I would just amplify it this way – tops tend to end with wide swinging movements until the finally die out. And it does look like a slow roll over after the fact. But if you’re involved in one, the action can be pretty violent – especially with one like we had in 2000, which ended the biggest bubble in history. Bottoms, on the other hand, tend to, as you say, drop then bounce, then test the lows, and finally just kind of die due to lack of interest when people decide that the stock market is dead forever (which is one of many reasons that I don’t think we saw a major bottom in March).

But in regards to tops and bottoms and how they relate to the COT report – we have data going back to 1986. We just haven’t seen enough major tops and bottoms since then to know. For example, 1974 was a major bottom. 1982 was a major bottom. 2000 was a major top. I guess you could make the case that the Crash of ’87, or whatever you want to call that thing in ’98 was major. But the Crash of ’87 was severe, but it was over before you could blink your eyes. And the ’98 decline was over very fast as well. Also, in those instances, the commercials went net short about a week before the Crash of ’87. So the timing couldn’t have any much better. In ’98, they went net long after the market took a huge hit, but you would have had to endure about a 10% (20% if you were using margin) drawdown in your account if you had gone long when the smart money went net long. Of course, it ended up paying off fabulously.

I think what happens is that big commercial traders don’t have to be concerned as much with timing as you and I do. I think they tend to start selling when they think stocks are relatively overvalued and they tend to start buying when they think stocks are relatively undervalued. And it eventually reaches a point where according to the COT report they become net short or net long. I think that, if anything, history has shown that they tend to be early. And my point in the Smart Money Report was that this last reversal on March 28 is rather unusual in respect to the fact that the market has almost gone straight up since then.

But that’s a good observation about tops and bottoms. You must be a student of the market. It’s always nice to find other people who find this stuff fascinating

Larry

Hi Larry,

Many thanks for the interesting reply and the kind comments - although I think you overestimate my abilities! My trading account shows a rather dismal understanding of the markets!

Your response triggered another question in my mind - is there any correlation between the size of drawdown one endures following the commercials lead and the size of the subsequent move? It just struck me that if the commercials are moving earlier than usual because they perceive the market as being extra overbought or oversold then they might subsequently push it that much further in the opposite direction. Perhaps I'm looking for some confidence building during periods of drawdown!

Thank you again and best wishes, Nic

Nic,

No, I have never noticed a correlation between the size of the drawdown and the subsequent move. That doesn't mean that there is not one. That's one reason that I urge everyone to do their own independent research. I'm sure there are many trends and correlations that people can come up with that I've never noticed.

The commercials don't move as a single entity. At any given time there are many longs and many shorts. So the commercials are primarily battling each other. The most that the commercials have ever been net long is 61%. The most that they've ever been net short is 43%. So they are never in overwhelming agreement. It's when the scales get tipped a little to the bull side or bear side that makes all the difference in the world.

Managing drawdowns is simply a matter of developing money management skills - use of margin, stop loss orders, timing mechanisms, exit strategies, etc. All the COT report does is give you direction (which is a huge advantage). The rest is money management. Money management is very difficult to write about beacuse there are so many variables and things to consider. That's probably why there have been very few books written on the subject. But I write about it often in one way or another both in the Smart Money Report and on this forum.

I think it was the great trader Paul Tudor Jones who said, and I'm paraphrasing here, "Amateurs worry about profits. Professionals worry about losses." That's so very true.

Larry

Hi Larry,

You keep mentioning that there is a lot of money on the sidelines. Can the amount of money on the sidelines or in the market be determined adding the "commercial long and commercial shorts"? For example the sum of the two for 06/03/03 is 860,950 (438,228 + 422,722).

David

David,

When I talk about money being on the sidelines, it's just based on my observation of how the markets are behaving. When markets move as sharply up as this one has and every slight decline immediately attracts buying that takes it to new highs, that tells me that the upward move caught a lot of people unprepared and now their fear is missing the bull move. I don't know of any way to measure it quantitatively. Just call it an educated guess. The number of longs and shorts tell you the open interest in the futures markets. I know that some people study open interest patterns, but I never have.

Today was the first day in quite a while that the decline wasn't supported by a lot of buying. I mentioned that we had a reversal day on Friday. Every other time that has happend since late March, buyers quickly took the market to new highs for the move. It didn't happen today. So maybe this is the start of a consolidation phase that I think would be healthy for the market.

Larry