Here are the 10 basic steps of my system. This takes me about 10 minutes to do each week. And if I've got any trades to put on, perhaps another 10 or 15 minutes. [Note that I am currently subjecting my system to more testing as described in this note and am temporarily combining it with technical indicators for trading. - A.R., Nov. 28, 2008]
1) Download latest Commitments of Traders data after the report is released each Friday at 3:30 p.m. (EST).
2) Cut and paste it into my spreadsheet for each market.
3) Calculate the latest numbers for the groups of traders I am watching for each market - i.e., their net position as a percent of the total open interest and their total open interest (long plus short positions).
4) If I get a new signal in a market, I look up the "trade delay" and figure out when to take the trade. The trade delay varies for each setup and is the number of weeks that was historically most profitable to wait before executing the trade. I believe the delays work because it can take time for extreme trader positioning to impact underlying markets or for that positioning to start unwinding and reverse course, which can change market trends. (To see the delay periods, got to my "Latest Signals & Results" page, click the link for the main table, and see the "Trade Delay" column. Trades always take place on the weekly open of trading.)
5) Risk-Control Rules
Some traders believe controlling risk is more important than their actual strategy for timing trades. Here are the risk-management rules I use.
(A) Highly Correlated Markets Rule (a.k.a. the Don't-Bet-Against-Myself Rule). If there is a new signal in a market, I check my table of highly correlated markets (see below). I take the signal only if a majority of the setups in any highly correlated markets are also trading in the same direction. If not, I ignore the signal. For example, if my BKX Bank Index setup says to go long for Monday, May 19, I check my setups for the two markets that are highly correlated to BKX - the Dow Jones industrials and Russell 2000. I take the BKX trade only if at least one of those is also bullish or will be bullish as of May 19.
(B) Diversification Rule. I won't allocate more than 25 percent of my total assets in one direction (i.e., long or short) to any one group of highly correlated markets (for example, gold, silver, copper, platinum, crude oil and heating oil).
(C) Black Swan Rule. How to deal with historically unprecedented market events has bedeviled traders. Such events are sometimes called "statistical fat tails" or "Black Swans" - anomalous markets that defy regular statistics and can blow up a trader. In the case of my system, they can lead a setup to get stopped out because it experienced a loss larger than anything seen in the past data. Add up a few major losses or trades that get stopped out, and my account gets depleted in any unacceptable way. My Black Swan Rule is designed to control this kind of risk. It has two parts. One applies to individual trading setups, the other to the overall trading system.
(i) I will cease trading any individual trading setup for four weeks that was stopped out because of a loss greater than the setup's past maximum drawdown. Four weeks is hopefully enough time to let markets settle down and allow the data come back into usual alignment.
(ii) In any four-week period, if my portfolio experiences a loss greater than six percent (calculated using the weekly close values), I will close all losing trades on the following weekly open and close winning trades if they experience a drawdown of greater than two percent. I will also cease trading new signals for four weeks.
[Scroll down for the last five rules...]
6) Look up the maximum portfolio allocation for the trade, then calculate how much to put into the trade. (See the "Portfolio Allocation" column in the "Latest Signals & Results" table.) I may scale into the position by allocating half of the maximum allocation on the entry date, then adding the remainder one week or more later if the trade has shown a profit (with the second entry based on the price action).
7) Find an appropriate security for the trade. I mostly use Exchange Traded Funds. I like to frequently check this regularly updated ETFs list at retired Royal Bank of Canada analyst Don Vialoux's excellent technical analysis website DVTechTalk.com.
8) Execute the trade for the open of that day.
9) Look up the stop level for the setup (see the stop column in the "Latest Signals & Results" table). This is the point where I'd sell in the event of a loss.
10) Relax and do other stuff for 10,055 minutes, until the next COTs Report.
7) Find an appropriate security for the trade. I mostly use Exchange Traded Funds. I like to frequently check this regularly updated ETFs list at retired Royal Bank of Canada analyst Don Vialoux's excellent technical analysis website DVTechTalk.com.
8) Execute the trade for the open of that day.
9) Look up the stop level for the setup (see the stop column in the "Latest Signals & Results" table). This is the point where I'd sell in the event of a loss.
10) Relax and do other stuff for 10,055 minutes, until the next COTs Report.
Highly Correlated Markets Table
S&P 500: Dow Jones industrials
Dow Jones industrials: BKX Banks Index, S&P 500
NASDAQ 100: n/a
BKX Bank Index: Dow Jones industrials
Nikkei: n/a
Natural gas: n/a
Gold, copper, silver, platinum, heating oil, crude oil (all highly correlated with each other)
Notes:
1) I defined markets as "highly correlated" when their weekly open prices have greater than 0.85 correlation between March 1995 (the start of the combined futures and options Commitments of Traders data) and the end of 2007 (the end of my test data).
2) Markets like the Nikkei and NASDAQ 100 that have the notation "n/a" aren't highly correlated with any other market. These uncorrelated markets are useful for building diversity into my portfolio.
3) No trade will be taken in the case of an equal number of long and short setups in highly correlated markets.
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