COT Conflict is Bullish Beans

April 6, 2018 02:31 PM
Advanced Technique

The CFTC’s COT numbers can be broken down in various ways, and they all are suggesting soybeans are headed higher. 

The logic behind the use of the Commodity Futures Trading Commissions’ (CFTC) Commitments of Traders (COT) report is that the commercial traders are more intimately familiar with a market’s fundamentals that provide their livelihood than are the speculators. Speculators tend to come and go from one hot market to the next. Here, we’ll explain how the commercial traders are connected, show you their actions in the soybean futures market, and explain how we employ their efforts to trade the markets three different ways.

First, the commercial traders in the soybean market are companies like Archer Daniels Midland (ADM), PotAsh (POT), Cargill () and John Deere (DE). Companies like these have an interconnected web of board members. Consider that Terrell Crews sits on the board of directors at ADM, Monsanto and Hormel. Gregory Page of John Deere’s board is also on Cargill’s board with Jeff Ettinger, who is on Hormel’s board, which is also shared with the previously mentioned Terrell Crews, as well as Consuelo Madere of PotAsh. 

This is not to suggest collusion or malfeasance in any way, just merely pointing out the interconnections of the people making the decisions at the highest levels. The board of directors’ information is available for all public companies. It just takes a lot of digging and cross-referencing. We could go on: Janice Fields of Monsanto also sits on the board at McDonald’s (MCD) with Richard Lenny of ConAgra (CAG) and with Jeanne Jackson of Kraft-Heinz (KHC).

Our research has shown that the commercial traders tend to be right about market direction more often and in a more predictable way than speculators. These companies, and others like them, have increased their net position by more than 125,000 contracts at prices between $9.45 and $9.80 per bushel in a five-week period in December and January, and added more than 165,000 contracts in total over six weeks in a similar period. We’ll look at weekly and daily data along with seasonal, discretionary and mechanical trading strategies that have all picked up on the recent burst of processor purchases in the soybean market.

Working from macro to micro, let’s begin with the weekly soybean chart (see “Macro bean action,” left). We have two setups on this chart. We’ve developed seasonal analysis based on time of year and commercial trader behavior. This study forecasts buying the March soybean futures throughout the first quarter. It’s a multi-step process. We’re nearing the window of opportunity while waiting for the market action to dictate the actual entry signal. The red arrows on the chart indicate the exit bar for this trade during the last few years with the profit or loss labeled, accordingly.

Secondly, you’ll see the setups for our Discretionary COT Signals on a weekly scale. We’ve plotted the net position of the commercial and speculative categories of the COT data in the bottom pane. This shows how their actions play out during the longer term. Notice the way the commercial traders begin buying or selling before a market’s top or bottom. This is similar to the current situation as commercial traders added the first 40,000 contracts in late Q4, when the market engaged its decline. Furthermore, notice that they have their largest positions on at the market’s most important turns. The commercial traders were sellers at the 2014 high and buyers at the July of 2014 low. Also, notice that they nearly set a new record short position selling the summer of 2016’s rally. This shows that the commercial traders in the soybean market are equally split between the producer and processor sides of the industrial equation.

Discretionary COT Signals 

The discretionary COT Signals are based on a simple three-step process designed to exploit markets that are overextended compared to their value area. The value area is determined through the positions of the commercial traders that produce or consume the given commodity.

 Number 1: We only take trades in line with the commercial traders’ momentum. If commercial long hedgers are buying in to guarantee future supplies at a current price level, we’ll be buying as well. Conversely, if commodity producers’ forward selling of planned production is the dominant feature of the markets, we’ll be on the sell side.

Number 2:  We use a proprietary short-term momentum filter to determine if a given market has reached overextended levels (many commercially available momentum filters such as RSI can be used for this). We look for conflict between short-term market momentum and the commercial traders’ market momentum. This sets the trigger.

 Number 3: Once our short-term momentum indicator signals a reversal — back in line with commercial trader momentum — our trade is triggered. This creates a new position in line with the commercial traders’ momentum. The swing high or low created by the market’s short-term overextension will provide us with the protective stop point. Finally, we take profits upon the market’s return to its value area.

Our research has shown that by tracking the momentum of commercial hedgers’ buying and selling, we are able to capture subtle nuances in commodity market behavior that help predict turning points with tradable accuracy and risk tolerances. Our method allows the markets to tell us when commercial traders are buying and selling as well as how eager they are to get their trades done at given commodity market prices.

Repeatable Patterns

Commercial buying early in the year has led to a repeatable pattern. Moving to the daily chart and our Discretionary COT Signal setup you’ll notice the same layering of data and analysis (see “Daily signals,” above). The Discretionary COT Signals are our most sensitive trading methodology. Part of the reason for this is we have examined this data for 25 years, which alerts traders to tradable situations in a repeatable manner. The discretionary signals are a purely mean reversion, swing trading methodology. The fight between the commercial and speculative traders takes place at what become the swing highs and lows of a market’s movement. Speculators tend to be trend traders, while commercial traders are more often range traders (mean reversion). What the commercial traders see as the top or bottom of their actionable range tends to be precisely where the speculators are expecting the market to break out and develop a new trend. This reversal strategy is the equivalent of betting the “don’t pass” line on a craps table. The commercial traders rebuff the speculative attacks more often than not and send the speculators back to lick their wounds. 

The results of the interactions between the commercial and speculative traders can be plotted daily. 

The Discretionary COT Signals provide an entry action along with a protective stop-loss price. Users’ discretion determines when to take profits.

This methodology uses pattern-based protective stop-loss orders. After trading for 25 years, you learn to control risk. Always trade with a protective stop loss order working in the market. The stop losses are always calculated at the recent swing high or swing low. 

Mechanical System 

Finally, let’s move into the purely mechanical soybean futures trading program we’ve developed based on the COT report. When you look at “Mechanical bean signal” (above), notice that the protective stop-loss orders are no longer placed at the swing highs or lows. We need to give the market a bit more room on the mechanical side. Therefore, we calculate our stop-loss orders as a percentage of the market’s opening price once the signal is triggered. The argument between static and dynamic stop loss orders has raged since trading began. Static orders allow us to know precisely what our pre-trade risk will be. Furthermore, our percentage-based stop-loss orders are based on extensive statistical analysis to determine when we’re throwing good money after bad and should pull the plug and take our loss.

Dynamic stops, on the other hand, do allow us to vary the stop in accordance with current market action. However, doing so requires trading with a blind eye toward ultimate risk. We don’t know how volatile the market could become once we’ve initiated a position and may find that intra-trade risk and corresponding stop-loss adjustment exceeds our risk threshold.

“Mechanical bean signal” also shows the results of our mechanical COT soybean trading system for the same period as the Discretionary COT Signals. During that period, it produced eight winners for a total profit of $9,325 and six losers for a total loss of $2,912.50. 

You can see that the June long position absorbed some heat as the market continued to make new lows for more than a week, before turning higher, in line with the commercial traders’ bid through July. Also, the recent spurt in commercial buying reversed the mechanical position from short to long. Currently, all three of our forecasting models: Seasonal, discretionary and mechanical are flashing bullish signals in Q1 2018 as the commercial processors continue to ensure the raw materials necessary to meet their contracted obligations. We’ll side with the directors of the most prominent companies and continue to take our cues from commercial activity.  


About the Author

Andy Waldock, owner of the brokerage firm Commodity & Derivative Advisors and the subscription service, is a third generation commodity trader with over 25 years of experience on all of the main U.S. exchanges. Andy stays abreast of modern programming developments due to the trading programs he employs for his own account and managed money.  He can be reached at