The Smart Money Is Buying Oil
As oil sold off, the smart money in the futures market turned bullish. Meanwhile, individual investors turned bearish.
In the past, that set up a rally in oil prices.
The chart below shows who bought and sold during the recent decline.
The price of oil futures is at the top of the chart. At the bottom are indicators showing how bullish groups known as commercials and small speculators are.
The indicator in the chart uses data from the Commodity Futures Trading Commission’s Commitments of Traders (COT) report. That report details the positions of commercials, which includes oil producers and large consumers like airlines.
Commercials know they will always need to buy or sell oil. They use the futures markets to get the best price.
When commercials believe prices are going up, they take large positions ahead of the rallies. That’s what they did in the last month.
The COT report also shows what small speculators do in the market. These are individual investors who trade futures.
Weekly updates to the data show changes in the positions of each group. Tracking the changes can be profitable for traders. As a group, large investors tend to outperform small investors.
In the chart, the indicator converts the number of contracts each group holds to an index.
At 100, the group is the most bullish they’ve been in six months. At zero, the group is bearish.
Trends in the direction of the indicator show whether bulls or bears are increasing.
Leveraging Crude Oil Futures
Futures markets are leveraged. An individual can trade 1,000 barrels with as little as $3,500 in some cases. That means a small move in the price of oil could result in a 100% loss.
Because risks are so high, many individuals sell quickly. The chart above shows individual traders turned bearish as prices fell.
So, right now, commercials are bullish while individual investors are increasingly bearish. This shows traders who know the market best believe prices will rally soon.
Since they tend to be right more often than not, we should expect higher oil prices soon.
Michael Carr, CMT, CFTe
Editor, Peak Velocity Trader