Discover more from All About Trading!
Announcing a New Weekly Market Sentiment Report
Subscribe to the New Weekly Market Sentiment Report for Directional Guidance
Coalescence, your weekly report that shows all you need to know to understand and use market sentiment and positioning in trading but also in investing. This post can be used as an A-Z guideline for the report. You will find everything you need here to begin reading and profiting from the valuable information contained inside which is backed by solid research, back-tests, and diverse methods.
The table of contents for this post is as follows:
Structure & Edge of the Coalescence Report
Components of the Coalescence Report
More Educational Content
1. Structure & Edge of the Coalescence Report
The Coalescence report is composed of several proprietary market sentiment mid-term and long-term models that continuously scan for opportunities and imminent changes in the positioning of the big market movers which is translated by an imminent change in the direction of the underlying price.
Every Sunday, paid subscribers receive the report in the form of a post where they can read about the latest sentiment shifts or opportunities (if any) to come on the major markets covered.
The report is composed of 5 indicators with 9 different techniques that each give a conclusion on the next likely direction of the covered market. Every indicator and technique comes with its own interpretation and way of calculation.
The forecasting horizon varies between different models and is always specified in the commentary section which summarizes everything you need to know on what to expect (the technical details are always given prior to the commentary). Now, what is the edge (added-value) of the report?
Definition of the edge: The report presents a trading and investment edge easily incorporated in your trading framework. The most important elements to extract from the report are sentiment timing and trend homogeneity.
The two important elements you should retain while analyzing every segment of the report are detailed as follows:
Sentiment timing: When one of the models trigger a directional signal based on a strategy, a timing bias can be given (long or short) on a specific asset. This is used to help guide your pre-established bias on the underlying. This element can be considered the equivalent of a trading signal even though it is merely based on market sentiment algorithms backed by trading results.
Trend homogeneity: When there is no signal from sentiment timing, it is worth knowing whether you are on the same side as the big whales or not. Capital flows are important in leading the future direction of the market. This element can be considered the equivalent of a trend confirmation filter.
Patience is key with market sentiment. It is always better to wait on the sidelines and jump on the opportunity when the winds are in your favor.
2. Components of the Coalescence Report
The best way to use the report is to consider it as a gossip. It is always telling you what other traders have done, are doing, and what they will likely do. By analyzing the information contained in the report, you will be able to understand the expectations of the big market movers and thus, the ones you should follow. The below segments show the components of the report you should expect every week.
The Commitment of Traders Report
The U.S Commodity Futures Trading Commission (CFTC) publishes statistics of the futures market on a weekly basis called the Commitment of Traders (COT) report. The report has many valuable information inside, namely the number of futures contracts held by market participants (hedge funds, banks, producers of commodities, speculators, etc.).
Two main categories have to be distinguished before going further:
Commercial players: They deal in the futures markets for hedging purposes (i.e. to cover their operations or other trading positions). Examples of hedgers include investment banks and agricultural giants. Their positions are negatively correlated with the underlying market.
Non-commercial players: They deal in the futures markets for speculative reasons (i.e. to profit from their positions). Examples of speculators include hedge funds. Their positions are positively correlated with the underlying market.
The word big implies a sizeable impact on prices. Fundamentally, commercial players invest significantly in research and in understanding the product and therefore they tend to be slightly more informed than non-commercial players and this is why the algorithms give slightly more weight to commercial players when scanning for opportunities.
There are four strategies applied on the COT report with each strategy applied on every covered major currency (EUR, CHF, GBP, CAD, and JPY):
The COT1 strategy uses a normalization technique to detect imminent market shifts while minimizing lag as much as possible.
The COT2 strategy uses a statistical technique to detect sentiment extremes that are bound to reverse.
The COT3 strategy uses a deceleration filter to detect exhaustion in positioning trends.
The COT4 strategy uses a pattern recognition technique to detect imminent reversals in sentiment.
Every week, a full commentary is given with the signals on every market that details the important highlights. The commentary is the go-to part for every model as it summarizes everything you need to know about the market sentiment and positioning of the underlying.
The White Index
The White Index is a confirmation indicator used to help detect inflection points on the S&P500 index. It is a complex transformation of the market sentiment stemming from the options market. It is a daily calculation and therefore, if a signal is generated on any day, an update will be sent to all subscribers, otherwise, the White Index is always included in the weekly report with the necessary details and the latest signals as well as their performance.
One thing noticeable about the White Index is that it is a long-only indicator which means that it gives only buy signals based on timing.
Vision is one of the leading and most successful sentiment indicators I use to find powerful market reactions on the S&P500 index. It is a daily calculation and therefore, if a signal is generated on any day, an update will be sent to all subscribers, otherwise, Vision is always included in the weekly report with the necessary details and the latest signals as well as their performance.
The track record of Vision is one of the best among the other sentiment indicators which is why I encourage you to give more weight to its signals. Of course, quality is emphasized more than quantity as is the case in every indicator in the Coalescence report.
The Millennium Forecast
This segment of the report deals with the long-term binary projection of the US economy by using a complex model on the well-known ISM PMI, an economic indicator published on a monthly basis.
The model uses a sophisticated mathematical technique to predict a major top or bottom in the US economy. The ISM PMI is a sentiment report from the biggest manufacturers and thus, by using the model, an economic forecast can be made using market sentiment. The binary projection of the model can be one of the following:
Expansion: This label represents an economic non-linear expansion during a predetermined period. In other words, the model expects an increase in the ISM PMI which is extremely correlated with the US gross domestic product (GDP).
Contraction: This label represents an economic non-linear contraction during a predetermined period. In other words, the model expects a top in the ISM PMI.
The next Figure shows the values of the ISM PMI since inception around 1950 until April 2022. The model can be seen in the second panel. The signals generated use a very specific trigger to send out an Expansion or a Contraction signal.
Historically, the ISM PMI has had ~0.85 correlation with the US GDP which means that an increase in one is usually associated with an increase in the other without the assumption of causality.
The Millennium Forecast has two main benefits:
Long-term economic forecast which indirectly impacts cyclical stocks. This point relates to economists and investors.
Mid-term to long-term view on the S&P500 as the ISM PMI is heavily correlated to the index. This point relates to traders and investors.
This is why, three horizons of forecasts are given:
3 months: This is the direction of the future ISM PMI values for the coming 3 months. It is a binary output where expansion refers to an expected value above the current one (in 3 months) and contraction refers to an expected value below the current one (in 3 months). It is best used for mid-term directional forecasts of the S&P500 and cyclical stocks.
6 months: This is the direction of the future ISM PMI values for the coming 6 months. It is a binary output where expansion refers to an expected value above the current one (in 6 months) and contraction refers to an expected value below the current one (in 6 months). It is best used for mid-term directional forecasts of the S&P500 and cyclical stocks.
Variable: This is the direction of the future ISM PMI values until a new signal is generated (which can be between a few months to a couple of years). It is a binary output where expansion refers to an expected value above the current one and contraction refers to an expected value below the current one. It is best used for long-term directional forecasts of the S&P500 and cyclical stocks.
Cyclical stocks are equities that are heavily related to the economic cycle.
Bitcoin Tactical Sentiment Index
The Bitcoin Tactical Sentiment Index is a daily sentiment-based indicator which uses insights from volatility, direct surveys, open interest, and patterns to calculate a normalized value that shows where the inflection points are likely to be. It is displayed as a heatmap with three colors interpreted as follows:
Green: Unconfirmed bullish signal. Awaiting for the trigger which may not occur.
Red: Unconfirmed bearish signal. Awaiting for the trigger which may not occur.
Beige: Neutral state and no expected signal in the coming days.
The signal is only validated when all the conditions are met. This is shown through the green and red arrows on the price chart. As this is a daily indicator, you will receive an alert (in the form of an email) whenever a signal appears, otherwise, you will receive the updated charts every Sunday.
I suggest you keep an eye on any updates from this indicator if you are an avid follower of Bitcoin (which itself leads the other cryptocurrencies).
3. Track Record
Models and strategies must be backed by at least a track record that justifies using them in the present and in the future. This section shows the conditions used for the back-test. Below are the conditions:
The directional signal appears at the end of the day or week depending on the frequency of the sentiment technique.
The trade is taken on the beginning of the next day or week to simulate a realistic environment.
The exit of the position is done either after a specified number of periods (a pre-determined forecasting horizon) or by using a variable method.
Sensitivity analysis is performed on each algorithm to make sure it is not showing coincidental results. However, robust back-testing results are never a guarantee for any future results. In my experience, I have been using these indicators for a while and the forward tests are validating the back-tests. The following tables summarize the historical performance of the models.
The COT strategies have the following results when running the back-tests since 2006. The hit ratio is the number of profitable trades (or right directions) over the total number of trades (or total forecasts). The profit factor is the total gross profit over the absolute total gross loss, it is the amount gained when compared to 1 unit of loss. The average gain to average loss is a measure of risk and a quick glance to what you expect to gain when compared to what you expect to lose.
The White Index has a historical hit ratio of 64.58% with a profit factor of 2.00 and an average gain to average loss ratio of 1.09. The back-testing horizon of the White Index is since 2011.
Vision has a historical hit ratio of 67.74% with a profit factor of 3.07 and an average gain to average loss ratio of 1.46. The back-testing horizon of Vision is since 2011.
The Millennium Forecast is presented differently because it is about forecasting the direction of an economic indicator instead of trading an underlying, therefore, only the hit ratio is useful to the performance evaluation.
For the variable forecasting period, the Millennium Forecast has a historical hit ratio of 76.92%. The variable period implies that the forecast is valid until getting another signal in either direction.
For the fixed 3-month forecasting period, the Millennium Forecast has a historical hit ratio of 66.66%. The fixed 3-month implies that the forecast is valid for 3 months.
For the fixed 6-month forecasting period, the Millennium Forecast has a historical hit ratio of 76.92%. The fixed 6-month implies that the forecast is valid for 6 months.
The Bitcoin Tactical Sentiment Index has a historical hit ratio of 70.83% with a profit factor of 4.45 and an average gain to average loss ratio of 1.83. This implies that the index is very predictive. As cryptocurrencies can be extremely correlated, it can be used as a forecast for the whole cryptocurrency market. The only drawback of the index is the rarity of its signals, but the good news is that it is a daily index and therefore is updated 7 times more than the weekly sentiment indicators such as the COT report.
4. Special Requests
If you have specific markets you would like to have regularly covered (or even a one-time request), you can reach out to me for pricing. With enough demand for certain markets, I will add and remove a few in order to match demand.
At the moment, the basic selection covers the following:
The EUR currency which serves as a guideline for trading and investing on EUR pairs such as EURUSD.
The CHF currency which serves as a guideline for trading and investing on CHF pairs such as USDCHF.
The GBP currency which serves as a guideline for trading and investing on GBP pairs such as GBPUSD.
The JPY currency which serves as a guideline for trading and investing on JPY pairs such as USDJPY.
The CAD currency which serves as a guideline for trading and investing on CAD pairs such as USDCAD.
Bitcoin currency which serves as a guideline for trading and investing on BTC pairs such as BTCUSD.
S&P500 index which serves as a guideline for trading and investing on the US market index and its underlying stocks.
Relative trades can be very powerful when using the COT report. For example, a bullish signal on EUR and a bearish signal on CAD could give you a high potential idea on EURCAD which may be a better candidate than a bullish EURUSD or a bullish USDCAD.
5. Important Disclosure
Market sentiment is only one side of the story. It is not meant to be the sole predictor even though the back-tests and the forward tests show an added-value. You must combine it with your own investment ideas and research. After all, you have worked so hard to find a trading framework that works for you. All I am offering you is a tool to optimize it and to make it better.
I do not recommend using the Coalescence report to initiate trades or investments. Remember, the report has a mid-term to long-term view which covers a horizon of a few weeks to a few months.
Protect your capital at all costs and review the first section above so that you get the best of the report.
6. More Educational Content
More educational trading content can be found in my other newsletter (which has a free subscription plan). If you want to subscribe, refer to this link: All About Trading!