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Posted in Fast Facts, Financial Markets

Here’s Who The Real Smart Money Is, and Why I Would Not Bet Against Them

The Real Smart Money - Click to enlarge

The issue of long and short positions on the ES- Emini S&P futures of large traders came up In the course of my Twitter conversations. When I researched it, I found something that absolutely amazed me. The Wall Street conventional wisdom about the Commitment of Traders (COTs) position reports is apparently wrong! Can you believe that! The Street CW…wrong?

The CW is that the Commercials are the smart money and that small specs are the dumb money. But when I looked into it, the truth was exactly the opposite!

The CFTC puts out the the weekly COT reports for the various futures every Friday for the week ended Tuesday that week. I have found that the positions shown they are only interesting when the numbers for one of the reporting segments is truly extreme. The reporting segments are Commercials, whose primary business is trading in the underlying commodity, Large Specs, which might be hedge funds or other large speculating firms, and Small Specs, who are the schmucks like you and me trading from our laptops while sitting in our dens in our shorts and T-shirts.

I like to run the charts back as many years as I can in order to see where each segment’s positions are extreme. In between it’s hard to see any correlation between any of the reporting segments and subsequent market action. However, we often see consistent correlations between extremes being reached in one of those segments and the subsequent trend.

The tweet that brought me to this point had referenced the large specs in the ES contracts. But it only went back a year, and it made me wonder about the big picture. So I made a chart going back 5 years to get some perspective. This is what it shows.

The Real Smart Money - Click to enlarge
The Real Smart Money – Click to enlarge
Source chart from Barchart.com  (which is an excellent charting service by the way)

It turns out that the real smart money isn’t the Commercials after all. The real smart money is the Small Specs, the “poor schmucks” like me and you that Wall Street likes to belittle as the dumb money!

“How can that be?” I thought. Well, it’s not that the commercials and large specs are necessarily dumb money. But commercials’ primary business is in trading the underlying securities, so their futures positions are usually hedges against an opposite position in the cash markets. In the old days the nomenclature even referred to them as Commercial Hedgers. They are, in essence, the Goldman Sackers and Mohel Lynches of the world–the Primary Dealers trading multiple positions and HFTing their way to their daily skim. Their COT reported positions tell us absolutely nothing about how they are betting on market direction because we have no idea where they are in their underlying positions.

Ditto for the large specs. These are the giant hedge funds and managed money. They too have offsetting hedge positions. We don’t know what their real market posture is. Sometimes the COTs make them look wrong and sometimes not.

But the Small Specs are mostly directional traders. For the most part, they have neither the financial resources nor the algorithms to put on complicated hedge positions. They’re either long or short, not in all cases, but mostly. In my 15 years on the web conversing with successful futures traders on message boards, the one thing that has been absolutely consistent is that virtually all of them were chart traders, from daily charts down to minute charts. They all use technical analysis to the virtual exclusion of fundamental analysis, although they often fade obvious news reaction setups, usually based on studies of support and resistance on the charts.

While the small specs in the futures “can’t get no respect from the Street, I tell ya,” they are the smart money when it comes to knowing how to read charts and knowing how to trade on that basis. The chart above doesn’t lie. The data is clear. Every time the small specs been maxed out long since 2010 the S&P has subsequently risen for months. Right now they have an all time record long position. Are you willing to bet against them?

The Street may not give them respect, but I do. Jack Bogle either has his head up his ass or was blowing smoke when he said he never met a trader who could trade the market short term. I’ve been talking to people who do, every day for 15 years. They’re smart, they’ve dedicated their lives to doing something that is very hard to do and they do it profitably. They know how to follow Professor Berra’s axiom, “You can observe a lot by watching.” They know how to correctly process the information they gain from years of careful, committed observation, and accumulation of historical memory. And they have the guts and cool under fire to act on that information with confidence and precision when their systems tell them to. The Street and its mainstream media PR people may belittle them, but they have my admiration and respect.

I would not bet against them.

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