Trading Tips

Looking for Meaning in Big Open Interest Drop in S&P 500 Futures

Here’s something I noticed today that I found REALLY interesting.

First of all, take a look at this Commitment of Traders data chart for the last year. The green line is Open Interest. Notice the pattern of steadily lower troughs, as highlighted by the red trend line. The troughs come at each quarterly contract rollover period.

S&P 500 Futures Commitments of Traders Data through December 22, 2009

The reason this grabbed my attention was that Open Interest, meaning the number of active futures contracts outstanding, has been steadily declining through the year, even as the stock market has been rising. In other words, stocks have been going up in the face of increasingly less participation by the major institutions (those being the main players in the S&P futures).

Now look at how this year’s Open Interest compares to where it’s been over the last few years.

Monthly S&P 500 Futures with Open Interest

My initial reaction is to be concerned about the fact that the participation of the big players during this rally has been so light. Of course, on the flip side, it suggests there might be a lot of buying potential still on the sidelines.

I’m still mulling it all over, though. What do you think it means?

Trader Resources

If You Haven’t Already…

I strongly advise you to check out the 90-minute seminar John Murphy did entitled Applying Technical Methods in Today’s Trading and the Market Wizards Insights seminar videos available here. They are only available for a limited time, and I’m pretty sure that time is running short, so make sure to give them a look right away (no cost).

John Murphy is author of Technical Analysis of the Financial Markets, widely considered the bible of technical analysis. He was highly respected during his years working on television in the early days of CNBC, especially being the main pioneer of inter-market analysis, and continues that work today as the Chief Technical Analyst for I personally consider him one of the best in the business and remember eagerly awaiting his segments when I was a young trader and analyst.

The market wizards video features Jack Schwager, author of two books I always recommend to traders: Market Wizards and The New Market Wizards. Both offer a lot of great information and advice, and are extremely motivational as well. Jack periodically does seminars on the subject of the lessons to be learned from the Wizards. I’ve had the opportunity to see them on a couple of occassions. Obviously, there’s a lot of overlapping content from the books, but it’s more than that. Jack is a very good speaker and in his seminars he presents in a really accessible way the lessons and themes he’s learned from the traders and money managers he sat down with.

I can’t be more positive in my recommendation that you check out these two seminar recordings if you haven’t already done so. You will learn something.

Trading Tips

Watching for a Market Explosion or Implosion

I’ve written on several occasions, including my first ever article published in Stocks & Commodities, on the subject of using Bollinger Bands in regards to identifying trends, especially the early stages of them. Basically, I use the Bands to look for situations where a market is ready to make a big move. In reviewing the charts this morning I noticed just that sort of situation in the stock market. Check it out.


Notice how tight the Bands have gotten thanks to the relatively narrow range the market has been in the last few weeks. The BWI indicator at the bottom of the chart (Band Width Indicator) says they Bands are about 2.8% wide relative to the 20-day moving average. That’s the lowest BWI reading in a while. The Volatility Reference Indicator (my own creation) tells us where the current Band Width is in relation to its extreme readings for the last year. It’s at 0, meaning the Bands right now are the narrowest they’ve been in at least a year.

All this means we should be looking for something big to happen. The narrower the Bands get, the more explosive is the move which follows them. If stock volatility expands rapidly (which is what an expansion in the Bands from the current narrow reading would mean), you can be sure similar types of action would be going on in the dollar, bonds, and commodities.

Alas, the Bands won’t tell us which way the eventual volatility expansion will take the market. Other tools are required there.

Trading Tips

A Sample of Professional Market Analysis

I received an email a short while ago outlining the three reasons an analyst at CIBC World Markets has for buying EUR/USD right now.

1) Diverging perceptions of interest rate policy. Fed’s Bullard talks about extending asset purchases beyond the March cut off time while the ECB appears to be taking the 1st step in a exit strategy, tightening ABS standards. Nothing creates a better trend than diverging interest rate policy.

2) EU positive M&A interest (Reliance’s EUR 10 bln bid for LyondellBasil) should put an underlying floor under the market.

3) IMM spec longs were cut in half, taking over $2 bln out of EUR positioning. Spec’s are now as flat as they have been since the 1st week of Sept, leaving plenty of room for positions to be rebuilt. EUR/USD is running higher on the broader risk outlook but this will likely only further pressure fast money to get back involved.

Target the 1.5300/50 area for now, using the 55-day MA (1.4790) as a risk point for now.

I’m not in any way presenting this as a recommendation, nor do I make any judgement on the validity of his analysis. I only show it to you to give you an idea of the sorts of things market professionals look at in their work.

This is a real mix of methods. The first reason is fundamental. The second one is focused on flows. The last reason comes from positioning data (Commitment of Traders). The target and “risk point” are derived from technical analysis.

This sort of analysis is not atypical. Market analysts use an array of tools and techniques. They also write to an audience which themselves uses different methods, which means they have to frame their arguments in a way which is going to resonate with their readers. That means speaking to the types of things those readers are looking at and thinking about.

Trader Resources

Learn Technicals from the Guy Who Wrote the Book

The question about how best to start learning technical analysis is one that comes up quite often from new traders. Here’s part of the answer.

Technical Analysis of the Financial Markets is widely considered the bible of technical analysis. Author John J. Murphy is one of the market luminaries. He was highly respected during his years working on television in the early days of CNBC (he overlapped with John Bollinger), especially in being the main pioneer of inter-market analysis. If you’ve been following my posts here for any length of time you will probably have picked up on the fact that inter-market analysis is a major part of what I do in my daily work. John is currently the Chief Technical Analyst for I personally consider him one of the best in the business and remember eagerly awaiting his segments when I was a young trader and analyst.

Want to learn from the best?

Then click here and check out a 90-minute seminar Murphy did entitled Applying Technical Methods in Today’s Trading. No matter where you are in your learning curve, I’m sure there’s something useful you’ll be able to take away.

Trading Tips

Looking at Stock Market Internals for Confirmation

While I’m no longer a stock market analyst (I’m focused on forex these days), I still keep my eye on what’s happening in equities. It is, after all, a big inter-linked financial world.

One of the things I watch when looking at the big stock market picture is the Advance/Decline line. Basically, that’s a measure of how many stocks have risen vs. how many have fallen on a given day. Because there can be big swings day to day based whether the market is up or down, most A/D lines do something to produce a smoothed out reading. Some are cummulative figures. Others, like the one I like to look at, is average-based.

You can see it plotted at the bottom of this chart.

To be specific, the plotted A/D line above (blue line) is the 13-period exponential moving average of the difference between NYSE advancers and decliners.

I look at the A/D line as a confirming or diverging indicator. When the market is making new highs and the A/D is making new highs, you have a confirming indication. When, however, you have the market rising and the A/D line is falling you have a divergence. As you can see (highlighted by the red lines), that’s been the case recently. The market has been making higher highs and higher lows, but of late the A/D line has made a lower high and a lower low.

Divergences are warning signs. They indicate that something may not be quite right, but they don’t automatically mean the market is going to reverse. I have seen divergences persist for long periods before the market finally does change course. Also, sometimes they just don’t work out, like earlier this year. Notice how the market made a higher high in August, but the A/D line failed to do so. That divergence didn’t result in a turn down. Instead the market ended up taking off on another strong run.

Still, when you see a divergence in the A/D line, or any other type of “internals” indication, it gives you reason to be cautious. I certainly am that right now where the stock market is concerned. The recent A/D action has been very, very poor. This week’s low is below any since since the bottom in March. I would not be surprised at all to see the next rally up, if it comes, fall well short of the latest highs.

Trading Book Reviews

Book Review: Reading Minds and Markets

[easyazon-link asin=”0132354977″][/easyazon-link]I’ve recently been reading a book titled [easyazon-link asin=”0132354977″]Reading Minds and Markets: Minimizing Risk and Maximizing Returns in a Volatile Global Marketplace[/easyazon-link] by Jack Ablin. Ablin is a long-time money manager with experience in both the fixed income and equity markets. While at first glance I think a lot of folks would probably say this book isn’t really something traders would be interested in, I think there are some nuggets to be had for those with a fundamental approach to the market and those who like to have a big picture view of things.

I don’t know how well the title actually sets up the book. Clearly it was crafted to hit the hot button concepts. The book is primarily about asset allocation – picking the best place(s) to put money to work.  Ablin provides what he considers the five ways one can look a the markets (speaking mainly of stocks and bonds here, but thinking on a global scale) to evaluate areas of potential opportunity. For each of those ways he provides some ideas for metrics which can be used to provide the necessary relative analysis.

The discussion of different potential metrics I found quite useful. It stimulated some ideas for me in the things that I do, and I’m sure it would do the same for other readers as well. These are, of course, more macro measures looking at broader themes, but that’s the basic point. Ablin pounds the table quite frequently about the value of looking at things top-down.

High level portfolio allocation type books can sometimes be very dry and boring. This one is actually quite approachable. The author includes quite a few personal anecdotes from his experience managing funds, showing both his triumphs and the short-falls which motivated him to improve is knowledge and methods. My one gripe was that the book was written to a bit too low a level of reader. Obviously, that makes it accessible to a wider audience, but I personally found some of the written annoyingly basic.

That drawback aside, for those who are interested in top level asset allocation type decisions, or who want a set a tools they can use for macro level analysis, I think this is a book which can offer up a lot of useful tips and ideas.