I have updated my weekly spreadsheet to compare an investment in the S&P 500 index versus strategy #2 with a 2/1 leverage. I now have tracking for 1, 2, 3, 4, 5 and 10 year returns. According to my spreadsheet the S&P 500 (as of today) has a better 1, 2, and 3 year return while strategy #2 has a better 4, 5, and 10 year return.

At what point would someone have to say "I don't think the COT is predicting the market like it once did?" Would this be the case if the four year return was better for the S&P 500? Or the five year? Etc.

Just trying to be a smart investor and double checking my system that I'm using.

Dave

Dave,

With me it would be "broken" whenever I have reason to believe that the smart money is not using the futures market in the same ways that they have in the past. I have no reason to believe that.

But that's one of the reasons I think most people are probably better off using stops. If you don't have first hand experience with the reason it's worked in the past, rather than just the fact that it has worked in the past, you can't have the confidence that it will work in the future.

Larry

Larry,
Could you give a more general answer without regard to the COT. Do you have a technical principle perhaps by which you judge that whatever technical pattern you have been using has stopped working. For instance, I understand that the turtles had to increase the length of their channel at some point because so many people started to copy them. I don't know if that's true, but if it is, when do you know something like that?
h

Howard,

Yes, I can do that and the Turtle situation is a good example. Over time locals on the floor of the Merc and the Chicago Board of Trade figured out where the enry point was in the Turtle system. So they would wait for an entry to be trggered and faded it in an attempt to move the market against them in order to trigger their stops and profit for themselves. Linda Raschke called that technique "Turtle Soup." The Turtles detected this and adjusted. They adjusted their entry point and they would use "mental" stops instead of actual stops.

So it goes back to what I was saying about the COT. When the reason your system works in the first place stops working is when you should re-evaluate, not just the fact that it is not making money over a given period of time.

This also plays into what I've always said about system evaluation. It is not enough for me to know that a system has worked in the past. I have to know why it has worked. In other words, it has to make sense.

Larry

Larry wrote in this week's SMR: Also, I’ll probably make the COT Strategy more of a discretionary strategy than a mechanical one.

So is the COT strategy broke now? It's only a small part of out portfolio and is possibly going to become discretionary. According to my spreadsheet, over the past four years the strategy has lost around 19% while the S&P 500 has gained around 61%.

Three years ago the COT was the main focus of the SMR and our portfolio. Now it almost appears to be just a tiny piece.

Is this a system that has seen it's time but is no longer viable?

Dave

I would imagine that I’ll be short the stock market during much of 2007. The COT reports will have a major influence in that decision. If that means it’s broke, it’s broke. If it means it’s not broke, it’s not broke. I make decisions and I post them for all to see. I don’t know how much more clear I can be.

Things can change a lot in three years in this business. The growing influence of the E-mini contract has meant that it will be much more difficult for the combination of the two contracts to go from net short to net long or vice versa. That needs to be taken into consideration. I had to have a lot of historical data to develop the original strategy. I’m going to have to have a lot of historical data to make necessary adjustments and that’s going to take a long time.

Also, three years ago I felt we were in the early stage of the great bull market in precious metals. I now think we’re in the early years of the next stage where things really get exciting. So obviously I want the lion share of my portfolio to be allocated to the great bull markets. Even if the stock market goes down 50% from here it won’t compare to the money that can be make in a secular bull market.

Larry

Dave,
I don't know if others will agree or disagree but it appears that the COT report is evolving. I don't believe the original 0 line applies as it did in the bubble years. I tend to look for extremes rather than absolute positive and negative readings. As I posted before a level of -15,000 or higher has been a fairly good buy signal and once the report drops below -40,000 it has generally been fairly close to the top (I'm guessing these would corespond to roughly 20/80 on the blees report). The generally negative bias for the last 4 years would suggest that Larry is correct and that we are in a secular bear market, just as the generally positive bias pre 2000 denoted a bull market. I do tend to look at typical cycle lengths and percentage gains in uplegs before shorting but the low net readings have all been fairly good signs of the bottom of a correction. It cetainly appears that the COT is still relavant it just doesn't appear to follow exactly the same guidelines as it did in years past.

For what it's worth.

Gary

The rules changed when the Fed loosened it's monetary policy after 2001 and flooded the market with liquidity and low interest rates. The housing bubble resulted, and brought more money into the financial system in the way of higher stock market returns. So these distortions have changed the rules, at least for the time being.

Gary - I am interested in modeling your theory in one of my spreadsheets. I have a few questions:

- Say you are guestimating an 80 or more Blees as long and a 20 or less Blees as short. Are those indicators signals of when to flip from long to short and short to long? For example, if you are currently long then you wait for the Blees to pass below 20 then you go short. You then wait until Blees passes 80 before you go long again. Is that correct?

- Are you just using the S&P 500 COT or are you combining with the E-Mini S%P 500?

Thanks,

Dave

a system that underperforms is not necessairly broken. several years back the "dogs of the dow" was very popular. various versions popped up:

there was the original version, the "pups" of the dow and the motely fool's "foolish 4".
once everyone started watching it it seemed to stop working... i.e. it seemed "broken".

but go here & look at this: http://www.dogsofthedow.com/

YTD 2006
Dogs of the Dow 24.8%
Small Dogs of the Dow 35.2%
Dow 30 18.2%

both the pups and the dogs beat the averages in 2006. does that mean it's fixed or that it was never broken?

i think the logic behind the dogs AND the cot is sound. however, if the cot is being futzed with - i.e. if the commericals are hiding their tracks in the mini's or other indices, then that has to be investigated... which larry is doing. but the basic ideas behind the two systems are still logical!

the COT system, which follows the big traders, IS still logical!
(my humble opinion, of course).

the dogs system, buying blue chip stocks cheap and earning a decent income IS, and always was, logical.

however, a truly good system still will not produce a profit every single year.

the market and the world are dynamic - evolving and ever-changing. no system is a simple cash machine. the point is to find yourself in the market - what makes sense to you in your own mind. think it, test it, then do it.

as long as the system was good in the first place and the information your getting is still true then it should work over time.

unless you, the trader are "broken".



happy new year!

-ja

Dave,
I'm just looking for correlations between the COT report and the market movements. Studying the COT history several things have become apparent. Extreme levels have generally been decent levels to look for timing bands for a trend change. The same as gold, silver, oil, natural gas. If you happen to have the COT history back to 2000 you will notice large declines in net short positions in Apr & Oct 01, Jul & especially Oct 02. The levels were still high by current standards but they gave pretty good signals that the commercials were relaxing their selling and that a rally was eminent. If Larry is right and I think he is then the commercials are still signalling their intentions in the futures market. I just think that the dividing line floats up and down. The mechanical positive/negative worked very well during the bull market but we appear to be in a different investing climate now. It doesn't appear that the commercials are going to flip to positive in this inflationary, bear market enviroment but we are certainly going to get rallies just like we did from 66-82. We have 2 wars going on and a commodity bull market not to mention having had a major terroist act. I can see how the commercials would tend to stay at least slightly negative at all times in this risky enviroment. I think the goal is to adapt to the current COT data as it evolves so as to catch the rallies. Even our commodity investments will probably do better if we can catch them when the market is rallying. For the past 4 years low net short positions of under -20000 have been pretty good levels to go long and extreme levels of -40000-50000 have been pretty good levels to short from. I'm guessing we will soon get another leg down in the bear market and the commercials will continue to add to their shorts on the way down instead of lifting them as they have done for the past 4 years. I'm with Larry I think that 07 will offer the best shorting opportunities in the last several years. We have had 6 uplegs in this bull market. The parabolic nature of the current advance would suggest that all fear has been washed out of this market. Parabolic advances usually don't end well, just look at gold, silver and natural gas this year. If you like I can e-mail you a spread sheet with historical data and a screen shot of buy and sell signals.

Gary

In general, you can tell that a system is broken when the developer begins to change rules, or "reoptimize" the settings.

Larry,
I'm just curious you said you felt confident that you would catch the bulk of any decline. Yet we had an excellent opportunity to profit from the decline in May & June but didn't capitalize on it. Instead we kept our long positions in commodities which resulted in 17 of 20 losses. The CRB is/was clearly in a bear market but we didn't catch any of it. I totally agree we are in a secular bull market and am just waiting for this cyclical bear to end. The COT is currently at extremely high short positions which have eventually turned every rally except the first stage up from the Mar 03 bottom. You seem to be looking to buy commodities on weakness now instead of waiting for a PSAR buy signal, ex. SLW. With the CRB trending down and the S&P futures heavily short this seems like a dangerous time to add to long positions. If we do get a large correction or resumption of the bear it seems unlikly that there won't be at least some drag on our commodity stocks. Also wondering why you would want to wait for weakness to sell our COT position instead of selling into strength like the commercial traders. I hope you don't take this wrong, I'm not critizing, you have made tremendous gains in the last year and a half. I'm just trying to pick your brain as to the reason for some of the changes.

Gary

Gary,

If you would ask me very specific questions I would be happy to answer them. I read your post and I'm not sure what you're talking about. So ask me questions without all your comments about what you think is a bear or bull market and how you interpret the COT reports and I'll be happy to answer them even though I think I do a pretty good job of explaining what I'm doing in the SMR.

Larry

I'll give it a shot. You said you were confident that you would catch the bulk of any decline. What are you looking for that would signal that the bear market has resumed?

What should we have been looking for or what did we miss to spot the cyclical bear market in commodities? Are the signs different to spot the beginings of a bear in commodities as opposed to a bear market in stocks.
I'm using a drop of 20% or more as the defintion of a bear market.

Also wondering what you would be looking for that would signal the correction in commodities is over? If you think it is over then it does make sense to buy on weakness rather than wait for a PSAR signal.

Gary

Gary,

That's much better. Now I think I can answer your questions.

I'll give it a shot. You said you were confident that you would catch the bulk of any decline. What are you looking for that would signal that the bear market has resumed?

I'm looking at technical and sentiment indicators. That's about as specific as I can be. And I'll be guessing and probing. But I'm mainly managing money. So I don't let myself get in situations that are going to hurt me. My basic overall position is to be short stocks and long commodities. Remember the most important chart in the world is the Dow/Gold ratio chart. If stocks go up, gold will go up much more. If stocks go down, gold will still go up or not go down nearly as much.

What should we have been looking for or what did we miss to spot the cyclical bear market in commodities? Are the signs different to spot the beginings of a bear in commodities as opposed to a bear market in stocks.
I'm using a drop of 20% or more as the defintion of a bear market.

I don't care about cyclical bear markets in commodities. If you're calling that little thing we had in May and June a cyclical bear market, to me it's just a little blip on the chart. I mean what do I care if silver goes from $14 an ounce to $11 an ounce? I'm not going to liquidate my positions to avoid it. And I'm damn sure not going to go short. The big money is going to be made by hanging on for the long term. It's the secular trend that matters. One of these days commodites are going to take off on the upside and make it very difficult to get in. People trying to trade in and out are going to get their heads handed to them. I know that from experience. Others will have to learn it on their own. And, unfortunately, some will have to learn it the hard way.

Also wondering what you would be looking for that would signal the correction in commodities is over? If you think it is over then it does make sense to buy on weakness rather than wait for a PSAR signal.

I already have a substantial position in precious metals and copper. I'm going more without stops than I have in the past. Therefore, it helps reduce drawdowns to buy on weakness rather than on strength.

I hope that helps.

Larry