On the other hand, when the sentiment is going down at some stage of a bull market - be cautious. It is another important trading rule.
In this post I want to discuss these rules, taking gold as an example.
The chart below is an update to one of my favorite COT report - based charts:
source: COT Report
The first rule is well documented by this chart - the period below the yellow area comprises a bull market phase (the end of 2008 - September 2010). The rising gold prices were supported by high optimism among big speculators (their net position in gold futures was long; what is more - speculators were increasing their net long positions).
Then, although the gold prices were still in their uptrend, the speculators' optimism started to vanish (not rising or even lower net long positions) - the period below the area in blue. The signal was clear - the bull market was weakening or even ending (in fact, ending).
Well, it is history. The question is: What now?
As the chart shows, now the big speculators are holding very high net long positions. It means high optimism. And here is the main point:
- in the long-term the optimism has to be high in order to keep the incoming bull market going (if this bull market is really incoming)
- however, in the short-term I have to say (if my opinion is to be unbiased) that this optimism is too high - therefore a correction or, at least, a trading range should be expected.
However, the whole picture is really mixed. Below I am enclosing a few charts, documenting the current sentiment among two groups of speculators:
The chart below shows my sentiment index (built on the action taken by big speculators). It is clear that currently the speculators are overoptimistic (the reading is 100%)
The chart below shows net positions held by small speculators, the least informed class of market players. It is clear that small speculators are overoptimistic, taking an assumption that we are still in a bear market in gold.
However, from the bull market perspective, their net long position is relatively low (for example, at the end of the previous bull market they were holding 3 times higher net long positions than now).
Summarizing - in my opinion, what we see now supports the long-term bullish thesis on gold.
However, in the short - term I would not be surprised seeing a correction in gold prices (even a big one).