*Tracking a potential trade position on Cotton based on correlation patterns from COT data*
Welcome back to the blog and Happy Friday! It’s been a crazy week in the stock markets with some big price movements in popular assets such as GameStop (Yep, that one again) and the hotly anticipated Churchill Capital Corp IV SPAC after they finally announced their deal with Lucid Motors electric vehicle company that saw the share price of CCIV fall by more than 50% in less than 2 days. Just remember, any stock with that much hype around it is likely to get a reality check sooner or later and price almost always reverts back to its fair value based on fundamentals.
One good point to come from this weeks stock market moves is that Tesla is finally starting to drop in price and for the first time since last year, the stock price is back below the level I shorted at in December 2020! You can read more about my Put options trade in my previous blog post by clicking on the link below.
Anyway, let’s get to the topic of this blog which is actually a continuation and development on last weeks post on Commitment Of Traders (COT) report data and how one could use that to influence trading decisions. In this blog post I am going to go one step further and use the techniques and code I showed you last week to identify a current potential trading opportunity on the Cotton commodity markets.
If you haven’t read my previous blog post that was published on Friday last week, then I highly recommend you do so. It will explain how I obtain the data that is used to produce the analysis in this blog post and how I use python programming to produce ratios and charts to support a potential trade position. Click on the image or link below to read it now.
It is no secret that commodities have seen a resurgence in price since the covid crash of 2020. Cotton is one of these commodities that has seen price rise from lows of around $48.30 up to the recent highs this week of above $94! This is a gain of almost 95% in less than 12 months. The Cotton spot price chart is shown below.
Ignoring any COT positioning data or advanced technical analysis, one can see that cotton has been on a potentially over-extended bull run and has now shown signs of rejecting a previous price resistance zone. But that is not the purpose of this blog post. The purpose of this blog post is to determine if the producer and managed money position data from the Commitment of Traders report supports a short position on Cotton. So let’s look at 2 charts that show the two strongest correlations between positioning and asset price.
For the purposes of this blog and ease of coding, I have used Cotton futures pricing.
According to the correlation matrix, created by using 6 years of cotton futures price data and both long and short managed money positions and long and short producer positions, the strongest correlations where between asset price and managed money LONG positions and asset price and producer SHORT positions. These have been plotted on the charts above.
As you can see on the charts above, over time, asset price and the long/short positions of each class of “trader” tend to move inline with each suggesting a strong positive correlation. This is good, but I wanted to produce something more like an indicator to find where the positioning of managed money and producers tend to produce big movements in asset price. I decided to create a ratio.
The chart below show both the long/short ratio of managed money positions.
To calculate the ratio, I simply divide the long positions of money managers (or producers) by the short positions to produce a ratio number. For example, a managed money long/short ratio of 10 would mean that there are 10x more long positions than short positions of managed money on cotton assets.
In my opinion, this ratio can be used to find the previous ratio levels for past movements on cotton asset price and therefore these ratio levels could indicate a big move in future. An example of this would be back in mid 2018 where the long/short ratio of managed money was just above 20.00 at a seemingly high value for the year and from there the price of cotton futures went on to fall from around $90 per pound down to less than $60 per pound the following year, which is a drop of more than 33%.
Even more interesting, is that the current value of the long/short ratio of managed money is now 18.88 as at last week and looking likely to push higher when this weeks data is released by the CFTC. This is approaching a similar managed money positioning as seen back in mid 2018 when the big drop in cotton price then occurred.
The chart below shows the long/short ratio of producer positions.
The ratio is calculated in the same way as the managed money ratio but using the long and short positioning of producers instead. Interestingly, looking at historic price movements, it seems that reversals and highs in cotton futures prices form when the long/short ratio hits extreme low values. This is most likely linked to the fact that it is the SHORT positioning of producers that has the positive correlation with asset price, whereas with managed money it is the LONG positions that have the positive correlation.
I am taking notice of the long/short ratio of producers in recent weeks and seeing that it is continuing to fall and headed towards historically low values. This could then be seen as a “signal” for a potential price reversal on cotton prices, in-particular futures pricing.
Considering both producers and managed money positioning is approaching historically low (and high) values respectively, and that cotton prices are trading very high, I think there is a sound argument for a reversal to come soon. That is why I am wanting to track this potential trade from this week onwards.
The two main things I want to look for are; if a price reversal on cotton does occur and if so, at what level do both the managed money ratio and producer ratios peak (trough). If they reach the same levels that past price swings have occurred at then we may be on to something tradable.
Firstly, as always… nothing in this blog post should be considered investment advice. Please make up your own mind and do your own analysis before entering any trade positions. I would also like to make it clear that I am still investigating and developing on the theories explained in this blog post and last Fridays blog post in regards to using the COT report data and managed money/producer positions to influence trade decisions. As it stands, I do not have a short position on any Cotton based commodities or derivatives.
What I am going to do is add the long/short producer ratio and long/short managed money ratio charts to my Weekly Chart Pack blog posts which are published every Tuesday. You and I can then track the future price movements of cotton futures and see if they are following the predicted plan outlined in this blog posts. This sort of analysis and “demo trading” is an important step when trying to find new trading strategies in the markets.
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