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FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
The reports by the Commodity Futures Trading Commission (CFTC) that are released on Fridays at 3:30 PM, contain a great deal of information concerning all futures traded on several exchanges. The futures that I am interested in are those traded against the S&P 500, the DJIA and the NASDAQ 100. Each report includes data from the previous Tuesday, so the chart below, which is of the S&P, is current only through July 22. Futures contracts are a zero-sum game, in that for every buyer there is a seller and for every dollar gained there is a dollar lost. The net long and short positions are listed for three classes of traders: Commercial, non-commercial (or large) and small. The data released tells us how many contracts are held long and short by traders in each class. I have subtracted the short from the long and plotted the net position for each of the classes. The light blue line represents the small traders, and you can see on the right axis that they are net long by around 79,000 contracts. The commercial and large traders are each net short and the total of their short positions equals the long positions of the small traders. It must always be the case that the total of the net long and net short positions equals zero. As you can see, the small traders have been very bullish for a long time, since early 2000. On the other hand, the commercial traders have been net short for most of the time that the small traders were long. The large traders have been somewhere in the middle, but have tended to follow the commercials recently. Notice also that from late 1993 until early 1996, while the market rallied, the commercials were net long while the others were short. On March 11th, the commercial traders, who we will consider to be the "smart money," were short by over 45,000 contracts. They turned bullish the next week and reached a high of 18,446 contracts long on June 17. However, the following week's report showed them to be 42,144 contracts short as of June 24. In just one week they shifted to the sell side by over 60,000 contracts. Interestingly, our Summary Index gave its sell signal on Friday June 20, right between these two dates.
The chart is far too complicated with all three classes of traders represented, so I have simplified it in the chart that follows, by calculating a weighted total from the net short positions of the commercial, the large and the small traders. Since the commercial traders are considered the "smart money" and the small traders are not, the weighted total reflects this by subtracting the small traders net position from that of the commercial traders. This 13 year chart very clearly demonstrates that when the weighted total has been positive the market has soon rallied, and when it has been negative the market has declined. The trendline drawn from the tops reached at the end of 1999 and the one made in the fall of 2001, was violated to the upside on September 17, 2002, just a couple of weeks before the October market bottom. This can be seen more clearly on the next chart, which covers a shorter period of time.
In addition to the trendline, to which I just referred, there are several others both up and down, the violation of which resulted in trend reversals by the S&P. One of the most dramatic incidents was the very sharp reduction in short contracts held by the commercial traders just before the March 11th market bottom. This is represented by the vertical rise in March, and was followed by a sharp vertical descent on June 17, just 3 days before my Summary Index sell signal. The chart reflects the fact that the commercial traders became more bearish last Tuesday, sending my weighted composite of net positions down towards the up trendline. If the commercials reduce the size of their net short position so that the composite fails to penetrate the trendline, the market may be due for an upturn. However, if the trendline is violated, there is a strong chance that the market will take a dive. In any case, we have to wait until Friday at 3:30 PM to find out.
There is one major question that will have to be addressed. Similar information is available for both the NASDAQ and the Dow Industrials, and while the NASDAQ is reasonably similar to the S&P, though a bit more extreme, the Dow is opposite! It may mean that traders are hedging their short positions in the S&P and NASDAQ with long positions in the Dow. Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
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