bruce babcock interviews steve briese

3/6/2015 Bruce Babcock Interviews Steve Briese

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Reality Based TradingCompany

presents

Bruce Babcock

Interviews

Steve Briese

on

Trading with the

Commitments ofTraders

Report



Steve Briese is the world's foremost authority oninterpreting the CFTC's Commitments of TradersReport. Along with his own successful trading, he hashad a distinguished commodity career as a newsletterpublisher and software developer. He has some veryunique and effective approaches to trading.

Now 47 years old, Briese was born in Minneapolis,where he grew up. After two years at St. John's College,in 1968, he left to fly helicopters in the Army. This wasat the height of the Vietnam War. As he explained it,"My father had been a prisoner of war in World War II.My grandfather had served in World War I. I justthought I ought to go and find out what it was all about.There wasn't anything I found out there which made mefeel we shouldn't have been there."

When he left Vietnam, Briese was the highest decoratedofficer in the history of his unit. It took him a long timeto get his feet back on the ground. He said, "it tookthree years to return to some sort of normalcy. When Igot back I couldn't stay put in one place. I wasconstantly traveling. Looking back at it a few yearslater, I could see that for three years I really didn't havemy wits about me."

Steve believes his experience as a combat helicopter



pilot had a very positive effect on the rest of his life. "Ioperated under extreme stress and under thoseconditions became the best that there ever was atsomething. So it did build selfconfidence. I have livedthe rest of my life feeling if I was going to get it, thatwas when I was going to get it. I don't have any fear ofdeath. I don't have any fear of anything else. When Itook around, I see that as a big advantage over atremendous number of people who fear all kinds ofthings."

He reenrolled in college, but again left, this time tohelp at his father's structural steel fabrication plant.Together they built the business to the point where itbecame a tourist attraction for Japanese who wanted tocome and copy the most advanced steel fabricatingplant in the world. As he described it, "A dozen peopleshowed up with notebooks and tape measures. Beforewe knew what was going on, they photographed andmeasured our entire plant in detail, every piece ofequipment. That's how the Japanese became such anindustrial power."

In 1976, he left that business and for awhile flewhelicopters in Alaska. Then he managed an employmentagency for a year. Through that, he found a perfect joband placed himself as national sales manager for a



specialty contracting company. He worked there until1982, when he started his own commercial roofingbusiness. Over the next seven years he built thatoperation to 60 employees.

On his 40th birthday, he decided to go on to somethingelse. He found other jobs for his key employees and justclosed the business down to concentrate on publishingthe commodity newsletter he had purchased theprevious year and trading for his own account.

At that time, Steve was not a newcomer to thecommodity markets. He had started trading in 1973after reading Anyone Can Make a Million Dollars byMorton Schulman. "The best and most explosiveinvestment in the entire book appeared to becommodities," he explained. "I went to a local firm tosee if any of the brokers was trading commodities. Sureenough there was a guy there who took Larry William'shotline and had commodities on his screen all day. Iopened a $3,000 account and bought three silvercontracts at $2.97. It went straight up.

"I rode it all the way to $3.60. I thought it had gone farenough for a while. I got out and then decided I mightas well make some money on the correction. I wentshort and was ahead for about a day before the market



locked limit up for three days in a row. By the time itwas over, I had lost my $3,000, and I owed the brokeranother $3,000."

Steve didn't give up, however. "After I paid the brokerback, I went about creating another account. At thattime (1974), I discovered the Commitments of TradersReport. I subscribed to that and looked foropportunities. I was searching for extremes to goagainst the small traders.

"The nice thing about the Commitments report was itonly came out once a month. It might be several monthsbefore you'd see a situation where there was a bigspread between the trading positions. When I foundsomething that looked cheap on the charts and smalltraders were in the opposite position or had no position,then I'd buy. I didn't have any real system, but I begankeeping my own price charts with open interest,Williams %R and the Commitments data.

"Typically, I would make some money and then lose itback. I was making enough though to stay interested. Isoon realized that even if I lost money, if I'd done justthe opposite, I would have made a lot of money. So Ikept working on developing some kind of methodologyto trade by.



"By 1983 you could buy a personal computer. Youcouldn't do much with it yet, but it wasn't too longbefore there was software available to do some things. Istarted programing in 1983 with the first portable thatcame out. It was a CP/M machine.

"In 1987, after the stock market crash I decided that thecommercial construction business was not going to bebooming. I started looking around. I'd been interested incommodities all this time and decided maybe I couldmake a living at it and do what I really wanted to do. "Iresolved to develop a methodology to trade. I did someresearch into who had organized a Commitments ofTraders data base and where I could get it. I cameacross Curtis Arnold who had been publishing theCommodity Insider newsletter but had just quit. Hecouldn't make a go of it.

"I negotiated to buy his research which consisted of hisdata base and his formula for the COT index. Hisformula was a stochastictype oscillator based on thecommercial positions. It made a lot of sense. I startedmy own newsletter in March, 1988, publishing netposition charts and COT indexes. In fact, I talked to youat that time and used your mailing list to get started.

"I decided the newsletter should pay all my living



expenses and overhead. Then I wouldn't be under anyparticular pressure to live off my trading. That's the wayI organized it. Even with five kids, within six months Iwas able to live off the newsletter and trade on theside."

Steve used his programming skills to create a number ofcommercially successful commodity programs. "I hadpeople sending me systems all the time, wanting me asa partner to sell their system.

"One guy kept faxing me his signals every day for sixmonths. He finally convinced me he had something. Imade a deal with him, and developed a softwareproduct called System Tracker. The theory was to takemany publicly available systems and methods, keeptrack of their trading, and then get into and out of themarkets a little before they did. We rented the programfor $300 a month to 50 people, with the customer beingable to apply up to three month's rent to the $10,000purchase price. 49 bought it. We still have one personwho continues to lease the program for $300 a month.

"That same system developer later invented analgorithm for trading currency cross rate spreads. Steveturned it into a software product they sold called CrossCurrent. It traded the Japanese Yen against the three



European currencies. It came out in August, 1992, andpurchasers made "tons of money" the first year.Although the currencies died down somewhat since, thesystem is still a highlyrated performer. It is currentlyavailable from, coincidentally, Curtis Arnold.

Steve also marketed a stock index system by RogerAltman called Private $tock. He hasn't run a trackrecord on it recently but says, "We have people whocontinue to trade it." He also created a unique chartingprogram primarily for his own use called, Auto Pilot.He has recently reprogrammed it for Windows. Itcontains some indicators available nowhere else such aslglehart Percent New and Hurst Envelopes.

My interview on April 25, 1996, continued:

Can you summarize your trading approach withrespect to entries, exits and stops?

I think the bottom line to my approach is that if you aretrading a methodology, a technical system, the technicalsystem should dictate where stops and entries go. Thetypical trader, however, probably can't afford to tradewith the risk that most systems create by having a largedistance between the entry and the exit.



The route most system developers have taken aroundthis is to adjust the stop loss. It becomes a money stop."I can't afford $1,000 risk on this, so I'm just going toput a money stop in at $500." I think that's entirelywrong. If you're going to take a position, you should beable to stay with the position until the market tells youthrough your technical analysis that you are wrong. Ifyou get out ahead of that, you're not really followingany kind of technical system. I continue to believe thatusing standard chart patterns is a very lucrative way totrade.

You're talking about classical chart patterns.Triangles, head and shoulders, that kind of thing?

Yes. Edwards and Magee. I also have a manuscript ofthe charting course which preceded that book. It wasnever published in book form. It was a trading coursepublished by an uncle of Magee. I've gone back to lookat what has worked and tried to reduce the chartpatterns down to a manageable few. I have two that Ilook for.

Which are?

The first is a failure swing top or bottom, which you canconsider to be a double bottom or slightlyhigher



second bottom.

Bruce Gould's 123.

Or the last half of a head and shoulders top or bottom.Or the last two peaks of a triple top or triple bottom.These are reversaltype patterns.

The other one is a coil. That would include any type oftriangle which is a consolidation. It is typically acontinuation pattern, but it can also be a reversalpattern.

The problem with these patterns is that to trade abreakout and put your stop on the other side of thepattern usually creates more risk than I want to take andthat most traders should take based on their accountsize. The typical approach to this would be to trade thebreakout when it comes, but to put your stop at a moneyrisk distance from the entry.

I take the opposite approach. First, I determine wheremy stop loss should be based on the pattern. I want toput my stop at the point where the pattern fails. Then Idetermine how much I'm willing to risk on the trade. Inmy case I never risk more then $500 per contract on anytrade. I don't trade the S&P, where that would be



difficult.

Is it a matter of personal comfort?

Yes.

On a 123 or failure swing, would your stop gobelow the first low?

Yes.

Go on.

I've established my stop, and I know what the exit pointwill be. Now I have to find the entry point that willkeep my risk within the required amount. This willusually be at a point before a breakout verifies thepattern, still within the pattern, I use other factors toforecast which way a pattern is going to complete.

You don't wait for a breakout and then try to buy areaction. You try to anticipate the completion of thepattern.

That's right. I use the Commitments of Traders data topredict the direction a pattern will complete. I'll giveyou an example in the Bond market. [See the chart.] In



the Christmas, 1995 issue of my newsletter, I describeda Special Situation on the short side of interest ratefutures. Based on the weekly chart I was looking for adouble top in TBonds. It was a huge pattern. I don'tcare how rich you are, you couldn't afford to wait for abreakdown below the 1994 low and put a stop above the1993 high.

That's a worsecase situation. Most people aren't goingto be trading patterns on a weekly chart. I was lookingfor a double top on the weekly chart because thecommercials were selling very heavily into the rally. Ielected to put on a position based on the weekly chartpattern with a stop above the previous high. Of course,that one worked to perfection.



You had to be pretty lucky to enter within $500 ofthe high.

When you know where your stop is and you know whatyour risk is, you are forced to wait for an opportuneentry. The market must come to you. In this case itworked out because I traded options on this trade. Itwas possible to do even with futures if you wereprepared ahead of time and had an order in to sell if theprice got high enough.

The high on the weekly chart was 12204. Do youremember where the futures were when you didyour options?

Yes, they were above 121.

That type of situation doesn't come along every day.

I'm giving an extreme example. We're still not even halfway down to the 1994 low, which is the point wherethis pattern will be confirmed on the weekly chart.People short from the top have made a tremendousamount of money already.

I find that the one thing even people new to the marketsare able to do is determine where they want to be out



the spot where they know they're going to be wrongtheir stop loss point. Typically, I ask them to find thatpoint. I tell them that's where their entry should be. Ifyou are getting in when everybody else is exiting, themajority of the time you will probably have an optionalentry.

That's a very intriguing idea. Where would you putyour stop than? That becomes a matter of risk.

I base that on a percentage of the account size, which Ithink should be one or two percent on any one trade.For smaller traders it's going to be a bigger number, butcertainly no more than five percent.

This sounds contradictory. You started out bysaying you don't want to use a nonchartbased stop.You use a pattern or some method to say where youshould exit. That's where you put your stop. Thenyou enter at a point which will keep your risk to theamount you want. Now you're saying forget all thatand enter at your exit point with a moneymanagement stop.

I'm using an outside indicator, in this case theCommitments of Traders Report, to predict thedirection of the next move. Typically the entry point is



much closer to the stop loss point than people realize.Quite often commercials are able to move a market tocollect all these ready stops and have a maximumposition before the market goes their way. So I think thestop is the most important thing, and the best entry isclose to that.

Your second strategy requires patience becauseyou're going to miss some trades when the marketnever makes it to your entry. It also requirescourage because the market is probably lookingpretty bad where your stop point is and you've got tobe stepping up to the plate. The key to yourmethodology is that no matter how bad the marketlooks, it's deceptive.

The market always looks the worst before it turns nearyour stop. Of course, I use the Commitments data topredict that a major turn is happening. Under thisprocedure you're going to find the optimum entry.

So you wouldn't recommend that type of procedureunless you were using the Commitments of TradersReport to establish direction. Would that be a fairstatement?

Yes.



Would trying to use it in other ways be dangerous?

I think so. I'm also saying this entry is superior to abreakout entry because the breakout entry is going to betoo far away from where the prescribed stop loss shouldbe.

I don't want people to be deceived. You're definitelysaying to use this only in conjunction withCommitments of Traders directional suggestions.

That's right.

I agree with you in the sense that buying weaknessand selling strength is ordinarily not a good way totrade. But you're going to make an exception herefor your Commitments methodology.

Yes.

Before we get to your Commitments strategy, westill have to cover exiting. I think you've done apretty good job of describing two different ways toenter. Now, once you are in a winning position, howdo you exit?

The exit is the real art of trading. There are a lot of



people who can enter right, but the exit is very, verydifficult. I prefer to use a trailing stop loss. What I lookfor is the point when speculators become heavilyinvolved in the market. You get what I refer to as aspeculative bubble. You can see it in the CommitmentsReport. At that time, I like to move my stop up behindthe latest correction low or high. I also have a systemthat looks at volatility. When the volatility doubles fromentry, I will take off half the position.

Volatility defined as what?

As the average daily range. I use the same time frame asI use for getting into the trade.

What would that be?

I use various time frames depending on the market. Forinstance, let's say I'm trading a breakout system in boththe Deutschemark and Swiss Franc. Since they are socorrelated, I use two different time frames. I don't wantto trade the same market cycle in both markets. Forinstance, if you're trading a breakout above a somanydays high, I might look for a breakout to a new 25dayhigh in one market and a breakout to a new 100dayhigh in the other. I would trade each market differently.The typical system developer looks to optimize a



system to only one time frame. Doing that, there wouldonly be a few complexes in which you're reallydiversified. You might have a choice of as little as sixmarkets to trade before starting to double up on thesame market forces.

What about the danger of curve fitting when youoptimize each market differently?

The systems I use typically are so robust that in termsof a breakout they might work from 20 days to 120days.

Why are they so robust? Because they have very fewparameters?

Sure. Number one, they have very few parameters. Andnumber two, the range of values for those parameters isso broad that it really doesn't matter which one youpick. You can pick with a dart what parameter valueyou want to trade. The key to increasing the smoothnessof your equity curve is that within a particular marketsector you should be trading more than one cycle. Thatmeans using grossly different time frames. As Ipreviously described, you could trade a 25day breakoutin one market and in a related market that tends to movethe same, trade a 100day time frame. Of course, you



must have a system that is robust enough to trade thosenoncorrelated time frames profitably.

That sounds like trying to combine longterm andshortterm systems in the same portfolio. There arepeople who will trade one shortterm system and inthe some account trade longterm as well. Thatwould amount to the same thing. Is that the ideayou're talking about?

Yes. To get back to my exit plan when volatilitydoubles, in order not to have an additional parameter, Iuse the same time frame to determine the average dailyrange as I used for entry. You lose degrees of freedomevery time you add a new parameter to a system. (That'sa statistical measure of reliability.)

The increase in volatility tells me this market hasprobably gone as far as it's going to go on this particularleg of the move. For instance, recently I had a systemthat went long Crude Oil on a breakout. Volatilitydoubled right at the top. I took off one contract at thatpoint.

Then you try to get back in some time later?

Yes. I try to get back in when the market reacts very



close to my current stop loss, so I have more or less theoriginal risk back in the trade. On a long trade I look fora big down day followed by a small inside day near thebottom of the first day's range. If that brings the riskdown, I put the trade back on.

For the rest of your position, you're trailing yourstop below the latest reaction low?

That's right.

You have some important ideas about moneymanagement. Can you tell us about those?

I determined with Cross Current [his currency spreadtrading system] that by using a pyramiding schemewhich adds to winning trades, you could drasticallyimprove the reward/risk ratio. With that system youcould about double it. Most system testing softwarepackages don't allow you to pyramid. Or to get out of atrade in stages either. That was critical to turning a soso system into a very successful system.

Another breakthrough came in measuring systemperformance. The available optimization routines usestandard performance yardsticks such as return onmaximum drawdown or total profits divided by total



losses. When you optimize a system's parameters, youare optimizing based on those benchmarks. Thosestandard ones are about the only choices. I found theywere not very good.

In system trading what you should be trying to do is tofind a systematic method of building an equity curvethat is as close to a straight line with as steep an angleas possible. The biggest drawback with most systems isthe lack of smoothness of that line. You want tominimize the movement around a straight line equitycurve. I developed a statistical measure which did that.It doesn't do any good, however, unless you canactually optimize for it, which is why I created softwareto do it.

Can you tell us more specifics?

No. It's proprietary.

How do you choose the best markets to trade?

I once analyzed a highlyrated system for its author. Hefound his system was profitable in three dozen marketsand from those he had various portfolios for varioussize accounts. He based his portfolio decisions on thetotal profits generated over a 5 or 20year period. Using



the standard system performance measures, which arethe ones he had available to him, such as return on totaldrawdown or total profits to total losses, itseemed/perfectly natural. But if you looked at myproprietary performance measure, you could see rightaway that many of these markets should have beenpoorly rated even though they were highly rated usingthe standard measures. I looked a little closer at theresults. Sure enough there were some grain markets thatwere very profitable for one year every f'ive or sixyears. But they made money so infrequently and hadsuch drawdowns in between, that they subtracted fromthe smoothness of the equity curve. Their equity curveswere so far from a straight line that they were not goodmarkets to trade with that system.

What about specializing in just a few markets or onemarket?

I once talked to a fellow who every spring invested$75,000 in Soybean options. I told him his strategy wasgoing to hit it big eventually, but it would probably bethe year he didn't have $75,000 left to invest. One of thebest things you can do is include as many markets aspossible in your trading that have shown consistentprofitmaking potential year after year.



What markets would you recommend? What are thebest markets?

We're talking here in terms of a trendfollowing system.The currencies historically have been tremendous yearafter year. Some of the international foods are good.Cocoa is a big exception. Most of the grains are notgood. Even though they look like it on a chart, whenyou try to trade them with a trendfollowing system,you find they just don't perform very well. Their bigtrends are too erratic and far between. They may havetrended well over time, but they don't performconsistently well year after year. Corn and Soybean Oilare the two best markets within the grains.

Can you tell me how many markets is a good corenumber to trade without specifying what they arenecessarily. Your system author had 36 markets,which was too many. When you weeded those down,how many did you end up with?

Eighteen.

Are you familiar with my book Trendiness In theFutures Markets?

Yes.



I first published it in 1988, and I update it everyyear. It is an objective examination of howhistorically trendy the various markets have been.

I would put the currencies first and interest ratessecond.

Exactly. Coffee's up there, and Orange Juice. I agreewith you 100 percent that Cocoa is not a goodtrending market. I don't trade Cocoa with systems. Itrade 21 markets with my various trend followingsystems.

I love the Cocoa market, but it has particularcharacteristics that don't allow you to trade it with atrendfollowing system.

I've suggested over the years that picking the properportfolio of markets is equally important withpicking a good system. It sounds like you agree withme on that.

Yes. It's critical. The problem is that the systemperformance measures available to the individual traderare not satisfactory.

Let me run another idea by you I feel strongly



about. Part of the problem with almost all testingsoftware Is that it only allows you to test one marketat a time. You can't judge what happens whenyou're trading a portfolio of markets together. Thisapplies to drawdown especially. My system softwareallows you to test a whole portfolio at once and seewhat the joint drawdown is. Do you agree thatportfolio testing is crucial?

Yes, and I do that as well. Your software has alwaysdone that, and I agree that it is critical. But it stilldoesn't give you the right answer if you don't have theright performance measure.

That is certainly food for thought even if you won'ttell us what it is. Let's turn to your Commitments ofTraders methodology. Why don't you start with thetheory of why It works?

In much the same way some people use the ElliottWave Theory or various technical measures todetermine how far the market will move and when itwill reverse, I view the Commitments data as a measureof crowd psychology. In terms of crowds, I can breakcommodity traders into three fairly homogeneousgroups. These three crowds happen to line up with thebreakdown of the Commitments of Traders Report. By



measuring their relative bullishness or bearishness, Ican determine the likely direction of a market. What I'mlooking for is extremes in sentiment. As soon as youtake a position, you have joined a crowd. You start tolose personal initiative and adopt the crowd mentality.Let's say you're watching CNBC. If an analyst agreeswith you, he's a very smart guy. If he doesn't agree withyou, he doesn't know what he's talking about. He's allwet. You tend to follow your crowd's leaders.

For those not familiar with this, would you describethe three different crowds we're talking about here?

The first crowd is commercial hedgers. They aremembers of one of two subcrowds in that they areeither producers or consumers. Producers would includesuch entities as mining companies, mutual funds andgrain elevators. These entities hold cash positions in acommodity and sell their commodity forward in thefutures market at current prices if they're expecting aprice decline.

On the other side are consumer commercials likemanufacturers and food processors who have acontinuing need for a particular commodity. If theybelieve the price of the commodity is going to rise, theybuy forward in the futures market to cover their future



needs.

What these subgroups have in common is that theytrade on inside information and they generally trade inonly one direction. Mining companies are always longthe physical metals, so they always short in the futuresmarket. Dog food companies always have an inventoryof meat byproducts or soybean meal, and therefore, theyalways buy in the futures market.

They're a homogeneous group. They are in the marketto reduce their risk from future price movements. Theyhave an offsetting cash position. If they are losing infutures, they are winning in cash. This gives them muchmore staying power than the other groups. They havedeep pockets to begin with. In order to belong in thelarge commercial category, they have huge cashinventories and huge futures positions. That makescommercials a homogeneous crowd.

The second crowd is large speculators. Some booksback in the 1970s, including Larry Williams' book, HowI Made One Million Dollars Last Year TradingCommodities, recommended that you follow this groupof large traders. At that time large speculators usuallygot that way through trading profits. Today the largetraders are primarily the commodity funds. They're



willing to assume the risk from commercials inexchange for an opportunity to profit. They aretypically motivated to show a profit every month, andthey're dominated by computerdriven, trendfollowingapproaches. Thus, they also tend to be a veryhomogeneous group. They became large by having agreat sales department, not by trading prowess. So Idon't follow them, but they are a very closeknit group.

The remaining large group is small traders. Thatincludes both speculators and small commercial hedgerssuch as farmers and others who don't have largepositions. What they have in common is that they havesmaller pocketbooks than either of the other twocrowds. They lack inside information and, therefore,they're more susceptible to news. This crowd tends tobe bullish if they are long rather than long if they arebullish.

These little guys are probably the most susceptible tocrowd psychology. Once they're in a position, theymake undisciplined decisions that after the fact theywould find illogical. While they're under pressure fromtheir crowd's mentality, they go along for the ride. Theyare the last ones in and the last ones out.

I look at the Commitments data as a very accurate way



to measure crowd psychology. From the work I havedone, I have determined that in most markets, of thethree, commercials are by far the best group to use as anindicator for most market conditions. The reason is theytake positions for the long haul and typically defendprice levels for long periods of time. I did a littleresearch study a couple of years ago that looked atextreme readings for each of the three groups todetermine whether price had moved in agreement withtheir position three months later or whether it hadmoved opposite. There are many ways to determinewhether a group is right or wrong. This is just one, butit confirmed my suspicions. Commercials were rightabout twothirds of the time. Small traders, who manypeople think are a good contraindicator, were right 45percent of the time. That's way too close to 50 percentto be useful as a contraindicator. Large speculatorswere very close to small traders. They were right 46percent of the time. Based on this, in most situations Ilook at the Commercial position.

Watching the commercials does one more thing for us.Nobody can be an expert in fundamentals in more thana few markets. Even being an expert in fundamentalsdoesn't mean you're going to make money trading thatmarket. People who trade with fundamentals aretypically commercials who don't need to be as accurate



as the rest of us. They have an offsetting cash positionwhich gives them more staying power. I look at thecommercial position as a measure of the unanimity ofopinion among commercial hedgers. When commercialhedgers get very onesided in a market based onhistorical patterns, you have a consensus formed thatcan determine major turning points in the market.

What about the argument that hedgers have tohedge, and they just go in and do it. They are notthat concerned about predicting market direction.They're just trying to hedge their cash needs.

That makes sense until you talk to the people who areactually doing the trading for these large firms. It turnsout the trading operation in many of these firms is nowa profit center. Their livelihood depends upon making aprofit on their hedges. While they can afford to bewrong, they don't want to be wrong. Their traders whoare putting on these positions, like any other trader,want to be right.

They have several advantages. The biggest is aninformational edge. If you look at the fundamentalinformation available to traders that doesn't come fromthe government, most of it originates from the verycommercial houses that we're trading against. In the



bestcase scenario, you assume the commercial houseshave already acted before they release their reports andprognostications. In the worse case, you might imaginethat what they actually release is not complete oraccurate. They are also better financed. Commercialshave a huge informational and financial advantage. Allmy research has shown they do make money on theirhedging.

Most of the time they aren't onesided enough togive a signal. What percentage of the time does theirtrading get onesided enough to say something?

I haven't worked out the percentage. But the times theyare onesided tend to be key reversal points. The verybest signals we get, the most reliable, are when a marketconsolidates and reacts from an ongoing trend.Typically when we see commercial buying come in ona correction to an extreme, it is a highly reliable signalthat the major trend is going to reassert itself.

We don't want to make this sound like too much of asure thing. It doesn't always work. Do you want totalk about that a little bit?

Sure. Commercials under the study I did were only righttwothirds of the time. What you find is that when they



are wrong, they can be very, very wrong. In his newbook on technical analysis, Jack Schwager talks aboutsignal failures being the most reliable of all chartsignals. When we have a signal failure on a commercialsignal (such as where Commercials are as bullish asthey have ever been in a market and it starts headingsouth), I view that as a signal failure. Those can be themost explosive moves.

You anticipated my next question. What about usinga reversal stop when you're trading one of thesecommercial signals?

That's the last part of Schwager's discussion. Hereferred to novice traders who ride their positions into abig loss. A more experienced trader will have a prudentstop loss to exit his position. But the really skilledtrader will do a 180 and reverse his position to go withthe move.

What I try to do in my work is not only pinpoint wherecommercials are aggressively onesided in the market,but also key points where I anticipate they are going tobe wrong, I've learned to identify certain patterns in theCommitments data that occur at major market turns.

Take the TBond market as an example. [See the



accompanying chart.] in 1993, I had spottedcommercials as very bullish. They held an extremelybullish position going into the spring of '94. Theirbuying had been concentrated at about the 11 3 level,which I then highlighted. "If the market breaks throughthis extreme commercial support at 113," I said, "thatwill be our signal failure pointthe point to go short." Itdid break through, and that was the worst year onrecord for bond prices.

Interestingly enough, commercials came in heavily asbuyers in October, 1994, triggering a minor buy signal.Their activity called both ends of the move in adifferent way. They were wrong at the top but right atthe bottom of that move.

I was looking for this rebound to become a secondaryselling opportunity. As prices came closer and closer tothe previous peak just over 122, 1 started to bet on adouble top. Commercials were the most bearish atChristmas time, just as prices threatened the previous1993 top. In this case the commercials were exactlyright. This is where you get a very highconfidencesignal: a correction to an ongoing major trend. I viewedthe major trend as having turned down in 1994.Commercials came in as sellers on the test of theprevious high and were exactly right. It is interesting to



note what happened across the interest rate spectrumafter the market broke from the second top but beforethat 3 point down day caused by the unemploymentreport. Commercials were buying with a vengeanceacross the interest rate spectrum. They boughtenormous numbers of contracts.

I viewed this as another indicator of a major topbecause what typically happens at these major highs iscommercials put in the top through their selling but thentry to hold the market within a narrow range by buyingafter a slight decline. When they buy in huge amounts,that's an indication of panic. What it means is they havesuch huge positions in the cash market that they try touse the futures market, where they can leverage, to holdup the cash market. What you find in these cases isfirms putting on what are called Texas hedges. They'relong cash and long futures, too. In this case I was able,as I have been time and again, to spot this panic buyingas a red flag and a red herring. It was an indication thatwe were going to have a substantial move against thecommercials.

It sounds somewhat contradictory. You say that thecommercials are mostly right and so you do whatthey do. But then you also go opposite to what theydo. You really have to know the specifics of when to



follow them and when not to.

That's why my newsletter's renewal rate is so high. TheCommitments data is readily available from a variety ofsources. The CFTC has even made it available on theInternet. Anybody can collect it for free and took at it.All the chart services publish net position charts thatshow what the positions of these trader groups are. Butanalyzing these charts is not a straight forward,straightline procedure. It's no trick to determine when aparticular trading group is bullish. The real trick isbeing able to determine when they're going to be wrong.I'm not suggesting you can bat 1,000, but I amsuggesting that when commercials are wrong, they tendto be wrong in such a big way that those are the moveswe don't want to miss. That's why you should try to spotthe key commercial support and resistance zones. Ifthey are penetrated, you want to go with that move.

Let's go on to the procedure. Tell us how youproduce what you print in your newsletter.

I started with a data base I bought from Curtis Arnold.He published a newsletter before I did. He had many ofthe markets going back to 1983. It took me a year and ahalf to fill in this data base for all the markets that haveenough open interest to follow. The data is monthly



from 1983 to November, 1990. In 1990, I started a lettercampaign to petition the CFTC to release the data morepromptly and more frequently. That actually broughtresults. Starting in October, 1990, we got reports on thefirst and fifteenth of the month that were releasedwithin three days. The data became bimonthly fromOctober, 1990 until October, 1992. Then they went toreporting weekly figures every other week. Theycalculate the net positions every Tuesday and releasetwoweeksworth every other Friday.

Much of the historical data out there is defective.There's a data source called Pinnacle Data which claimsto be the sole source of Steve Briese's COT Index, aswell as providing the Commitments of Traders Reports.What they have are Curtis Arnold's COT indexes. Heused a fixed time frame and did not adjust for changesin open interest, which have been extreme in somemarkets. So Pinnacle does not have Steve Briese's COTIndexes.

The government released the historical data Pinnacleuses in tape form in 1990. It goes back to 1986 andappears as twiceamonth data, which was not what wasreported at the time. It was not audited, and it is full oferrors. The government knew this when they released it.Most of the available historical data, including



Pinnacle's, include these faulty numbers.

My data is all from the original reports. For many yearsthe government couldn't always add correctly, so Iprovided error checking to them. To make sure they addup, I have error checking built into the program I use toread the numbers. I also have all the corrections thegovernment issued subsequent to the reports.

Do you sell your data independently?

I do.

How much is it?

$95 a year.

So if you want to go back ten years, it's $950?

No. I give away the entire historical data base goingback to 1983 with a oneyear update order. You get ayear's worth of future updates plus all the history for$95.

The updates are what you yourself download everytwo weeks using a modern? Couldn't a person justget the data themselves on the Internet?



Unfortunately, the Internet files are structured like aprinted report. They're not useful unless you are able toread the numbers into a chartable file. What I do is takethe electronically printed report, pull out the keynumbers and put them into commadelimited ASCIIfiles in a standard price file format. You can then graphthem in most commodity charting packages. They're inopen, high, low, close, volume, open interest fields.You can import them and create charts on your owncomputer.

Where do you get the data?

From MartinMarietta, which somebody else justbought out. I pay a hundred and some dollars a monthto collect the data.

Why do you pay so much when it's free on theInternet or from the CFTC?

I am programmed to process the file format that comesfrom MartinMarietta. I did revise my program toconform to the government's new format when theywent to the Internet, but then they changed the formatagain. I wasn't about to keep reprogramming every timethey change. So I stayed with Martin Marietta. Also, theInternet can be quite slow. Collecting that file has taken



me up to 45 minutes for something that should take aminute. I need the data right away, so I pay for it.

If somebody subscribes to, say, Commodity TrendService's chart service with the data in there, is thereanything wrong with looking at their charts?

No, that's the easiest way to do it. Then it's a question ofinterpreting the charts. But you offer quite a bit morethan just creating charts of the raw data. What I do inprocessing the data is create what I call the BriesePercent COT (Commitments of Traders) Index whichtakes the commercial position and compares it to anhistorical benchmark. The large commercial position isreported as so many longs and so many shorts. Isubtract the shorts from the longs to arrive at a netposition. I then compare that current net to the"maximum" and "minimum" net position historically.Those maximums and minimums are the most bullishand the least bullish positions over a specified lookback period. Commercials move from net long to netshort in most markets. All I'm doing is creating an indexwhich shows the current position's relationship to anhistorical period. How relatively bullish or bearish arethe commercials currently?

The period you use is different for each market, and



it's proprietary.

That's right.

The difference between what you do and whatCurtis Arnold used to do is that he used the sameperiod for all markets.

Correct. I have made one other modification which hasbecome necessary over the years. There have been hugechanges in the open interest in many of these markets. Ihave a proprietary open interest adjustment I use.

I don't understand.

Because we're measuring changes in the differencebetween longs and shorts, if the open interest increasessubstantially in a market because there is more activehedging from a particular group of suppliers orproducers, then the net positions might not be from thesame group you've been following historically. As theopen interest rises, the net positions you see chartedtoday may not be the same trader mix as comprised theprevious data points on your chart. For instance, FuturesCharts prints four years of data. As you see the openinterest rise quite dramatically in some of the markets,the mix of traders changes. I found a way to adjust for



that, so I get a more accurate ongoing reading ofrelative bullishness and bearishness compared tohistorical levels.

The percentage numbers you print in yournewsletter are percentage bullish. The higher thepercentage, the more bullish the commercials are ina particular market.

That's right. When I show a 100 percent COT Indexreading, that means the commercial net position, thelongs minus the shorts, is equal to or greater than thehighest it has been over the lookback period. A zeropercent reading means the opposite. That would be theirmost bearish position. The reason I use this index is thatthe mix of traders varies from market to market. Youhave to be able to read the net position pattern you seeby plotting the net position of Commercials, smalltraders and large speculators for each particular market.Patterns in one market will not work in another market.For instance, in some markets Commercials are almostnever net short. Yet in Silver, commercials have neverbeen net long. The reason they have never been net longis there are more producers (mining companies) in thefutures market than there are manufacturers who requiresilver. So the net hedge in Silver futures has alwaysfavored the short side. If you're looking at a Silver chart



versus a Gold chart, in Gold you'll see that commercialsreadily move from net long to net short, whereas inSilver they never get net long. It's a completely differentpattern. By using my oscillator, the COT Index, we cancome up with a uniform scale for all markets.

So the table you have on the back of your newsletteris quite different from the numbers that you wouldsee coming from the CFTC or charted in theCommodity Trend Service chart book?

Yes.

And in your opinion your numbers are a lot better touse.

If you're following two or three dozen markets and youhave to assimilate the net position patterns in each onedifferently, that's a difficult chore. By simply changingit to a uniform oscillator so that zero and one hundredmean the same thing for every market, it's much simplerto employ.

When someone gets your data updates for $95 ayear, does It include the COT Index numbers aswell?



Yes, it does. It includes them for each of the three tradergroups.

That seems like pretty valuable information for only$95 a year. A subscriber would receive on a biweeklybasis the same numbers you publish on the last pagein your letter, but not the three pages of analysis.

That's right. It creates a market interest in theCommitments data. What I have found throughwatching other analysts' work is that as this data hasbecome more readily available and more widelyreviewed, the quality of others' analysis is so poor that itincreases our readership.

Other people are so bad at this that you're lookinggreat by comparison. is that what you're saying?

Yes. And misinterpreting this data causes manyMonday moves that go the wrong way. My subscribersare able to take advantage of this on Tuesday morningafter they read my letter.

This happens because the data is released onFriday?

Yes, It's released on Friday after the close. You'll quite



often see a reaction then. When you read on the newswire what happened, it was that the Commitmentsnumbers came out.

If somebody has for instance, Omega Research'sSupercharts program, they could download yourdata and then figure out how to display it undertheir commodity charts?

As a matter of fact, I provide specific directions fordisplaying net COT Index positions in SuperCharts.

There's another number in your newsletter wehaven't talked about yet. It's called "move." What'sthat all about?

I look at two things in the commercial numbers.Number one, we want to look at the actual net positionin relationship to the historical period to see howextreme the current position is. If it's extreme enough tomove the index to about 90 percent, I call that, forsimplicity, a major buy signal, although subscribersshould not interpret it as advice to buy. It's simply anindication that commercials are buying in a major way.If it's extreme enough on the other end to get below 5percent on our index, I call that a major sell signal,which again is not necessarily an indication for



subscribers to sell. There is another way I like to look atthe data. That is to find out how much the commercials'net position has changed over a relatively short periodof time. If it's enough to move the index 40 points ineither direction within a sixweek period, that shows anunusual amount of commercial activity. I call theseminor buy and sell signals to distinguish them frommajor signals which, as I previously indicated, mean thecommercials have reached an historical extreme.

Typically, the minor signals provide key areas to buybull markets after corrections where the correctionnever gets deep enough to reach 90 percent on theindex. I look at how much the CoT index has changedin the last six weeks. If a minor buy or sell occursbecause of a substantial change, I will identify thatmarket with either a plus or minus sign.

Looking at your most recent letter, which is datedApril 15th. This is just prior to some truly hugemoves in the grains. Looking at your numbers forcommercials, the commercials are long in Soybeansonly 10 percent, in Wheat 33 percent, Corn 26percent, Soybean Oil 17 percent, Soybean Meal 23percent, Oats 32 percent. If one were looking atthese numbers in your COT Index, it looks like thecommercials are not very bullish. Yet the markets



are going bananas. Why isn't this going to fake youout?

The commercials are value buyers. They were the mostbullish when prices were closer to their value pricinglevels. I had a buy signal in Wheat in March, 1995, at345, a correction low. In Soybeans, I had a major buysignal in February, 1995, at 550. Beans are now above800. Commercials are not buying aggressively at thisprice because the market has moved well above thevalue level where they previously bought.

But they're not selling aggressively either. Is that thepoint?

This has been an interesting market. We've had new alltime highs recently in Corn and Wheat along withhistorically high Soybean prices, yet commercials arenot down to zero. That's why in that issue, even thoughthere weren't any buying opportunitys, I told subscribersthat this thing may have a long way to go from herebecause the commercials were not aggressively sellingthese rallies even at record prices. They can giveimportant indications even when they are not at extremelevels of buying or selling.



A clearcut example of this occurred in the Coffeemarket in 199394. That was a bull market many peoplethought came out of nowhere. Everybody assumed itwas nothing but a speculative bubble. Back inDecember, 1993, we had put in a bottom after a longbear market. There was a small double bottom inSeptember, 1992, and then a larger failure swing bottomin April, 1993. The commercials were aggressivebuyers on that failureswing bottom. In fact, it was justa couple of points short of a major buy signal on myindex. Then there was a long triangular consolidationthat lasted about six months. We broke down out of thatconsolidation in January, 1994.

What I saw was this. On that breakdown, commercials



came into the market. Their net positions moved to thehighest level in over two years. It was an indication tome that this was a bear trap. The international foods arequite famous for these because commercials dominatethese markets. They typically hold two thirds to threequarters of the open interest in the international foods.In Cocoa, Coffee and Sugar they are masters at gettinga maximum position at the most favorable price. That'swhat they did there. They moved the price downthrough obvious chart support at the bottom of the longconsolidation and then took it right back up. Everybodyassumed the initial move was a speculative rally, that itwas the commodity funds coming in and buying oodlesof contracts. The major portion of the move wasactually commercial buying. The large speculators wereselling into the move before it ever got going. Theywere selling at well below $1. They started selling at 85cents. As the market went up, volatility increased andthe open interest dropped substantially. That was largespeculators getting out. They couldn't stand the risk.The market continued to move on commercial shortcovering, and that's what propelled the enormous movein 1994commercial short covering.

When you see that situation, it is commercialcapitulation, which results in huge moves. For a similarcurrent situation, look at a Cocoa chart. We recently



saw a long consolidation and then an apparent downsidebreakout with a large contingent of commercial buyersahead of that. You could have anticipated that if therewere a downside breakout, it was going to be a beartrap. That's exactly what occurred. Then all of a suddenit was pushing 1400.

Would you summarize how you interpret theCommitments numbers?

Once I get the numbers and convert them to the COTIndexes, I look for two things. I look for the largemovement index numbers to see where there has been amajor change in the last few weeks. Secondarily, I lookto see which ones are at extremes: above 90 percent andbelow 5 percent.

Would it make sense to analyze the Commitmentsdata on a seasonal basis?

Commodity Research Bureau made that assumption in1985, and it was later repeated in a couple of marketbooks. They said the correct way to analyze theCommitments of Traders data was to compare currentcommercial positions with their seasonal averagepositions. It's a natural assumption to make. Farmers areplanting grain in the spring and harvesting in the fall so



there should be a seasonality to their hedging. I sent thedata to a Ph.D. economist and asked him to check it forseasonality. He concluded there was none. That's why Idecided not to print seasonal charts of the Commitmentsdata.

I thought I should show a demonstration of this so Idrew up the net positions of the commercials forSoybeans for ten years. People are amazed when theysee the chart. It's all over the map. There's plainly noseasonal pattern to it. You can create seasonal charts bymaking averages, but if you check them statistically,you'll find there's no statistical reliability.

If somebody read your letter for awhile, how long doyou think it would take before they could do theirown analysis without you?

I've been analyzing this data for 22 years. I typicallyspend 12 hours on each report, which includes writingthe analysis. Since I don't make specific tradingrecommendations, all I am doing is analyzing thereport. I can't believe there are many traders who havethat amount of time to spend, and I know there aren'tany who have that kind of experience. I can't see whereit's profitable for anybody to do their own analysis ofthe Commitments data when my research is so cheap



and readily available.

Yes, I see your point. I don't want to soundimpertinent, but you make this sound so easy andattractive. Naturally, our readers would want toknow if this is so effective, how come you're not richfrom trading it?

I think I am rich. I have five kids with just one left inhigh school. For the last dozen years I have coachedbasketball, softball and baseball. I have made enoughmoney in the markets that my family has beencomfortable and secure. I'm putting all my kids throughcollege. I've taken out of the markets what I've neededto meet my primary goal which was getting these fivekids off to a good start. I will have more time from nowon to concentrate on the financial aspect of my work.

So within your own financial parameters you havebeen successful as a trader using this?

Sure.

Is there anything we've left out?

When you think about the Commitments data, peopleoften think of it as a separate specialty area of analysis.



This is basically open interest that we're looking at.There was a whole book written on volume and openinterest. Here is a quick summary of the standard openinterest and volume analysis rules. (1) When price,volume and open interest are all rising, that's a strongmarket. (2) If the price is rising but volume and openinterest are declining, you'll have a weak rally. (3) Ifprice is declining with volume and open interest rising,you have a strong downtrend. (4) Declining prices withdeclining volume and open interest means a weakdowntrend. Those are the four rules of volume and openinterest interpretation you can read in books.

Here is the reality. In the first place, volume is not apredictive indicator in commodity markets. I don't know



whether it is in stocks or not, but I've proven it is nomore than a coincident indicator in the commoditymarkets. It's coincident with volatility. When you chartthe fiveday average volume versus the five day averageprice range and invert one, you'll see a perfectRorschach. [See chart.] You get a mirror image. As theprice range increases, more traders become active, morestops are hit, and volume increases. Volume is directlyproportional to volatility. Therefore, it is not apredictive indicator.

If you look at the four rules I spelled out, they workabout half the time. They work often enough sosomebody can show examples of their supposedeffectiveness. I could show just as many exampleswhere they don't work. For example, there wasdeclining open interest over the entire 1994 rally inCoffee. I don't think anyone will deny that was a verystrong rally, and yet it occurred with declining volumeand declining open interest, which is exactly opposite tothe classic rules.

Open interest is of paramount importance in marketanalysis, but you have to throw out all the old rules andlook at the makeup of the open interest in ariving atyour conclusions. By looking at the makeup of thevarious trading groups, whose breakdown the



Commitments data provides, you can tell when thoserules are going to work and when they're not.

What's the price of a yearly subscription to yourletter and what does it include?

$295.00. That includes 26 issues, a 16page subscriber'sguide with longterm charts of the various markets, plusa video. I gave an allday seminar in New York acouple of years ago and put the best of that into a 3hour video, which goes to new subscribers.

Is there any shorter trial subscription?

Yes, a 3 month trial is $95.

That sounds like one of the best bargains around.My thanks to Steve for this enlightening interview. IfI were limited to reading just one commoditynewsletter, I think I'd have to make it his BullishReview. You may subscribe to his newsletter ormodem update service by writing to Bullish Review,14600 Blaine Avenue East, Rosemount, MN 55068.Or call (612)4234900. Fax (612)4234949.

Reality Based Trading Company

http://www.lloyd.com/~babcock/welcome.html



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Copyright 1996 by Bruce Babcock, Jr. Allrights reserved.

bruce babcock interviews steve briese

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