The commercial traders in the S&P 500 Futures markets made an extreme move last week … the kind of move we rarely see.

They went from a bullish extreme to a near bearish extreme in a single week. Take a look:

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Now normally I look to trade with the S&P 500 commercial futures traders. Given that I wrote last week that I’m leaning bearish at the moment, such a huge bearish move on the part of the commercial traders should be a major confirmation of my bearish thesis. Right? I should be putting on a massive short position immediately. Right?

Not so fast … sentiment based indicators aren’t always what they seem. Sometimes even the market insiders rush over to the other side of the boat too quickly.

This chart shows a couple of the more recent instances of sharp sentiment drops by S&P commercial traders:

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While these sharp sudden sentiment drops did lead to some short term pain for the S&P 500, the important thing to note is that the pain didn’t last very long. Ultimately, the S&P 500 resumed its uptrend and continued marching higher.

In fact, I went back and looked at other extreme moves in S&P commercial trader sentiment from the past 30 years. There have been less than 10 such moves in the past 30 years. Here are all of them on a single chart:

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Prior to this most recent move, there have only been 8 such moves in the past 30 years. The important thing to note is that in 7 out of 8 of these moves, the markets moved higher shortly thereafter.

The following table shows the percentage gains in the S&P 500 1, 3 and 6 months after the sentiment signals.

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Across nearly all of these time frames, the S&P 500 was higher 7 out of the 8 times we got this signal in the past. The lone exception was in 1987 … and it was a doozy.

1987 was the granddaddy of all such sentiment drops. In August 1987 the S&P commercial traders went 99% of the way from bullish to bearish in a single week (as measured by the distance between the two red lines):

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One week later, the S&P 500 peaked … and two months later the crash of 1987 unfolded taking the S&P 500 down over 33% in a matter of weeks.

So … we’ve just experienced an extreme move in S&P commercial trader sentiment. 7 out of the 8 times such moves occurred in the past, the markets have disappointed the neo-bears by continuing to march higher … but once, the neo-bears nailed it – big time.

The bottom line here might surprise you.

Commercial traders are often called the “smart money.” Betting with them can pay off in certain markets. But in this case, the historical evidence shows that when they make a quick bearish shift, the market usually ends up higher six months later.

On our “weighting of the evidence,” this indicator goes on the bullish side of the scale. But it’s definitely time to check in on your portfolio and mind your stops. The one time this indicator was right was pre-crash 1987.

Staying alert,

Richard_Signature
Richard M. Smith, PhD
CEO, TradeSmith
Founder, TradeStops.com