FSU Editorial: "Net Commercials Lower Volatility" by James West 08/14/2006

NET COMMERCIALS AND LOWER VOLATILITY
by James West
forever a student of the markets
August 14, 2006

Broad Markets

Russell 2000 [ http://www.buythebottom.com/rut.html ]
COT data for the RUT was virtually unchanged and for me this is a bullish development as long as the net-commercial position remains in the 5 000 – 10 000 contracts range, or more; (currently at 10 380) I expect a significant rally to materialize down the road.
There are currently two scenarios that I am considering:
1 – Russell 2000 holds the 670 reaction-low, and rallies to its May-high at 760 – 780.
2 – Russell 2000 decisively breaks the 670 reaction-low, bottoms in the range of 620 – 640, and then rallies & tops somewhere in the 700 – 780 range.

I am of the opinion that the first case scenario will play out. I do not think that the Russell 2000 will ‘decisively’ break 670, by which I mean consecutive closes for the index below 665. Furthermore, if we do get a false breakdown, I will use it as a buying opportunity. (For example, if the RUT goes bellow 670, I will place a buy-order above 670 with very tight stops). The reason I favor the first scenario over the second is partially because of recent commercial buying and the strong bearish sentiment amongst the herd. Thus far this market is trading sideways, with critical support at 670 and resistance at 700-710. I will play a break to the upside or the downside. However, I am willing to bet more on the upside, because of recent commercial buying.

Remember: always be mindful of false-breakouts and false-breakdowns. Tight stops are critical for me: after all you can ALWAYS re-enter a position, especially if you are doing a good job preserving your capital by employing smart money-management. (Tight stops, betting small, hedging profits, etc)

I am primarily watching the Russell 2000 to gage where the other averages are headed. The other averages are still very important to me, as a confirmation tool. For example, if one average breaks above or below a critical level, are the other averages following suit, breaking their own respective critical levels? If YES, then the move is real, and is less likely to reverse. If NO, then the move is flagged, and is more likely to reverse. This (non-confirmation) should immediately raise an eyebrow until there is a confirmation from the lagging averages or until the leading average reverses.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Net-commercial position increased by 6 742 contracts, or roughly 2.2 billion dollars. What I forgot to mention last week, was that net-commercial position increased by 10 977 contracts or roughly 3.5 billion dollars. That means commercial inflow into S&P contracts over the last 2 weeks has been well over 5 billion dollars. Even though net-commercial position is -37 397 contracts, the recent influx of commercial buying interest is a bullish development. Whether we see this trend continue only time will tell. Critical support for the S&P 500 is at 1225 and resistance at 1290.

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
Net-commercial position is little changed, but net-large-trader position decreased roughly 2 000 contracts. Last week net-large trader position decreased roughly 4 000 contracts, this brings the 2-week total to approx. - 6 000 contracts. Large trader selling is a bullish development, and if you look at the COT chart, the blue line (representing large traders) is nearing -15 000 contracts; an area which may signify a market bottom, if one is not in place already. Critical support for the NASDAQ 100 is at 1450 and resistance at 1510-1525 area.

Dow Jones [ http://www.buythebottom.com/indu.html ]
Nothing new to report as far as the COT data is concerning, critical support for the Dow is at 10700 and resistance at 11300.

Crude Oil [ http://www.buythebottom.com/wtic.html ]
It is rather amusing that over the last month all I write for oil is: “Commercials continue to sell, while large traders are betting on the long side”. And then, when oil tumbles on news of a foiled terrorist attack everybody is surprised at the market. Well, this week commercials were sellers and large traders were buyers. And you know what, oil declined because of this setup in the market. I don’t care for why commercials are selling oil, but they are. And that is all I need to know. However, the downside is NOT $40 or $50 or even $60. I am still eyeing the 200 day moving average currently at $66.76. COT data and historical price data is telling me that this is where oil is headed and this is where oil is going to bottom. Until then, I am going to remain on the sidelines as this market corrects within a bigger picture uptrend.

Gold [ http://www.buythebottom.com/gold.html ]
I am still waiting for a setup in the gold market. I am expecting that we see more sideways trading before we see a big move to the upside. It looks like support for the metal is at 575 – 600 and resistance at 650 – 675. I will view a break below 575 as a buying opportunity. On the other hand if the market breaks above 675 – without commercial participation – chances for an abrupt reversal are high. None of this changes my longer-term bullish outlook for GOLD, OIL and other commodities.

US Dollar [ http://www.buythebottom.com/usd.html ]
Commercials are supporting the dollar in the $84 – 85 range. As long as this is the case, there is a higher chance for the dollar to rally and break above 87 than for the dollar to decline and break below 84. Critical support for the US Dollar is at $83.50; personally I would not dare buy the US Dollar Index below this level.

Final thoughts on volatility:

Over the last month, volatility has been clearly shrinking. And before any big move, this is exactly what happens: volatility shrinks. At the end of the day, I really do not care if this move is to the upside or the downside, my one and only goal is to be on the right side. As I stated previously, the Russell 2000 is my primary barometer to gage which way the market is headed. A decisive break below 670 would indicate a decline is in the works, and a break above 700 – 710 area would indicate that a rally is underway. Commercial buying over the last few weeks is painting a bullish picture for the markets, however, that doesn’t mean that we can’t go lower before we go higher.

So far, the market isn’t saying much, as is shown by the following chart of the Russell 2000. The key is to make sure that you are paying very close attention, as the market is almost finished writing its script is going to start reading its lines momentarily – and all this when everybody least expects it.

Remember, 670 vs 700-710,

all the best,
James

Updated weekly COT charts can be found @ www.buythebottom.com

Mailing list
I am organizing a mailing list to notify investors when I update the weekly cot charts and/or publish an article. If you would like to be added to the list, simply send an email to buythebottom (at) gmail.com and write “ADD” in the subject line. Conversely if you want to be removed from the mailing list once you joined; simply send an email to the same address and write “REMOVE” in the subject line.

CONTACT INFORMATION
James West
www.buythebottom.com
Toronto, Ontario, Canada
Email: westjam @ gmail.com (Remove the space before and after @ when sending your email)

The opinions of FSU contributors do not necessarily reflect those of Financial Sense