April 7, 2015
I often cite Commitments of Traders as one of my guides in selecting trades, due to my firm conviction that trading opposite the masses…when you know that everybody is basically “all in” on one side of a market…does eventually pay off. No, using this indicator doesn’t give you the exact timing (nothing does), but it often can lead you to positions, that, if properly risk managed while the market DOESN’T move in your favor, CAN lead to some potentially large profits…As always, however, I am obligated to note being wrong can also lead to losing every dollar you have on the table. After all, this IS a game of Rewards AND Risks.
But we have all seen it, time and time and time again, where 99% of the market blather is totally one sided…where all the “logic” suggests a market can only be going one way…and then it does EXACTLY THE OPPOSITE OF WHAT EVERYBODY EXPECTS. As I am forever repeating, “How many times do you have to see it?” The truth is, this really is pretty much the way the markets do work.
And this situation is precisely the set up I see in two major areas today…One being the Dollar (and Euro), the other being in Soybeans, which is the subject of this newsletter…
I am still buying Soybeans
The chart following may be too “busy”, but if you take the time to wade through it, you can’t help but note how the speculative crowd seemingly always does end up totally positioned on the wrong side of the market.
To hopefully simply what I want you to see on this Commitments of Traders chart, here are a few notes of explanation:
The chart is a picture of who is long and who is short…and to what extent.
Traders are broken down into three categories:
Red line represents Commercial Traders…Hedgers who actually use or produce the commodity.
Green line represents Large Speculators…or the Funds…Although they are supposedly smart money, they are NOT. Yes, there are a few superstars, but in general, they are just as habitually wrong as everybody else.
Blue line represents Small Speculators…who, as might be suspected, are the least sophisticated traders in the markets and the most inclined to trade off headline news and what the brainless talking heads are predicting.
On the chart, when any of these three are above the zero line, it indicates that group is net long…and conversely, when they are below zero, it indicates they are net short.
Specifically, I have enumerated the following...
#1 – Late 2007. This was the LAST time (7 years ago) both Large and Small Specs were short Soybeans. A year later Soybeans had almost tripled in price, having gone from $5.50 to just under $16.00 a bushel.
# 2 thru #7 – Various instances in which Large Specs were at record (for then) or near record Long levels, dead opposite the Commercials, which were ALL followed by varying degrees of sharp price declines…If you match up the numbers and do the math yourself, you see there’s one that was roughly $1.50…and all the others were substantially bigger. To be clear, these “smart money” guys were long exactly when it was time to be short.
#8 –For the past 5-6 months, Commercials are more long than they have ever been…Large Specs are short again for the first time since 2007…And Small Specs are the most short they have ever been.
This chart is already too crowded with information so I decided against adding any further notations…BUT, if you take the time to match up (connect your own arrows) what happened each time Large Specs got back down almost to flat (the zero line), you’ll easily see that large rallies followed soon thereafter.
When the whole speculative trading world is on one side of the market, my experience has been it often pays to go the other way.
As I wrote back in February, primarily as a function of the USA having produced a record Soybean crop last fall, the analytic and trading community are now seemingly more bearish Soybeans than I can recall seeing them in YEARS (which is exactly what you see reflected in the commitments chart above)…But, what I think all these people are forgetting/missing is that IN TODAY’S WORLD, RECORD CROPS ARE ALMOST AN ABSOLUTE NECESSITY.
Worldwide demand for Soybeans, the world’s number one source of vegetable protein, sets new records every year, and if you DON’T get frequent record production to meet that demand, I say you’d better be looking for prices headed into the trading stratosphere.
To me, this chart says it all…and in itself is a bit of an explanation as to how delicate the balance actually can be between world supply and demand. This chart says, “We’d better have record production”. Without it, there’s no telling how high prices could go into today’s world.
Here’s another bit of perspective…
Obviously, the fact that demand is forever expanding does not mean that Soybeans have to go up every year as world production is always attempting to increase as well…and consequently we do have both bull and bear markets in this commodity…However, while production CAN fall or slow its expansion due to farmer decisions…or weather…the same cannot be said regarding demand…IT WILL GET STRONGER YEAR AFTER YEAR (AND LATELY AT A FASTER PACE) SUCH THAT I WOULD CAUTION ANYONE ABOUT GETTING TOO BEARISH THIS MARKET…ESPECIALLY WHEN JUST ABOUT EVERY ANALYST OUT THERE IS PREACHING THE SAME NEGATIVE SERMON.
I don’t know when this is going to happen…I just 150% believe it will…And with speculative traders overwhelmingly short right now…and the commercials dead opposite them at record levels (reflecting BIG business they have booked but not yet delivered), I can’t help but think the lift off could be any time now…
As noted…We DO need record production…and this year’s crop has not even been planted successfully yet, nor do we have ANY idea of what obstacles our recent somewhat radical weather patterns may present between now and harvest…So I am therefore quite comfortable in buying and owning this market for the next 4-5 months…especially using the 1 & 1 approach as the last thing Soybeans seem to do at this time of year is go sideways...
ALL THINGS CONSIDERED, I CAN EASILY ENVISION THIS MARKET TRADING TWO OR THREE DOLLARS ABOVE CURRENT LEVELS. USING APPROACHES LIKE THE 1 & 1 SHOWN BELOW, I WANT TO BE POSITIONED FOR A BIG UPSIDE MOVE IN SOYBEANS UNTIL AT LEAST THE END OF AUGUST.
Start with this…take the time to scan this chart and take note of how common 2, 3 and 4 dollar moves actually are…
Here are a few approaches at today’s close…All options prices include all fees and commissions.
Or August gives you an extra month of time…
I am now using this 1 & 1 approach for the following reasons:
What happens when you are wrong in this stuff is more important than anything else. When you are right, the high leverage takes care of you and hitting for multiples of 3, 4 or 5 times (and up) is not pie-in-the-sky dreaming. Futures ARE highly leveraged and I don’t enter any trade unless I have calculated that a reasonably normal move will offer me those size potential returns.
But again, WHAT IS MOST IS IMPORTANT IS WHAT HAPPENS TO YOU WHEN YOU ARE WRONG…
When I take a position, I generally have not just blithely arrived at an opinion…and just because a market initially goes against me does NOT tend to change my opinion…And specifically, in this case, if Soybeans do drop lower (the “wrong” way), I will consider them a better buy…and if this strategy allows me to recoup 100% of my initial investment, and reposition at better prices, that is exactly what I want to automatically do…Sell both the call and put. Get my money back. Get back in. And I am willing to do this as many times as it takes…I do NOT decide, “Oh, I think it’s going lower. Let’s ride it.” When I can get my money back, doing so is AUTOMATIC. I do it and start over again.
On the flip side, if/when the market DOES start going my way, my attitude is just to “let it happen”, to give the market every chance it can to make the sort of money originally envisioned…and NOT see the move make a few bucks, get nervous, start thinking “What if it stops?”, etc…and let yourself exit the trade FAR too early. My recommended mentality, when something is happening, is: LET IT HAPPEN.
Of course, the caveat to all of this is that the market can certainly go sideways, in which case you could possibly lose everything you have in the trade, but as an options buyer, this is going to be the case with ANY strategy you employ, whether it be just buying calls or puts, or using the 2 & 1, or whatever. Sideways usually means losing when you buy options…but, to me, it also means the market HAS been sideways a long time and the odds of a big move have, I believe, only gone higher…And I will be ready to do it again. FUTURES ARE INHERENTLY VOLATILE.
Enough chatter for one day…except to say that you have no idea how excited I am about the potential I see with this “adjustment” to an approach I have used for years. As I’ve wrote in my last newsletter, it feels supremely stupid not to have realized it before (as I always mistakenly considered a 1 & 1 approach as “not enough bang for your buck”), but now that I am working with it, I can see that the strategy dovetails perfectly with the medium to longer term trading approach I have always used in the markets. As can be noted on the examples above, there IS plenty of leverage using this 1 & 1, and again, much, much more importantly, when you are wrong…it’s no pipe dream…You can get your money back and start over, which, in my minds presents the bottom line as: Potential for few losses. Plenty of potential for nice gains.
I’ll update the Euro, Dollar, Cotton, and Cattle in the coming days.
Give me a call if you like this. GREAT, GREAT numbers I think.
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Soybeans