Index Extreme

Although the index can show us traders’ sentiment, but we have to take note of extreme in positioning.

If traders’ net positions index is very high or very low we call it extreme positioning.

Extreme speculative positioning can cause liquidation of longs (supply) and covering of shorts (demand).

In case of hedgers, if we have extreme short positioning it is highly likely the market is topping and vice versa if we have extreme long positioning it is highly likely the market is bottoming.

Application

Red dark area means extreme short positioning (bullish) and vice versa blue dark area means extreme long positioning (bearish) if you are looking at speculators chart.

The best place to see the Red dark area is the valleys and the best place to see the blue dark area is the peaks for speculators.

For hedgers, the best place to see the Red dark area is at the top of the market and the best place to see the blue dark area is at the bottom of the market.

You have two plans if you see the index extreme signals in the charts for speculators. In case you are looking at hedgers’ chart everything reverses.

Red dark area:

If you are short and you see Red dark area and price action also signals beginning of a pullback, then you take out something to reduce your exposure.
if you are on a strong demand area and you see Red dark area, then you consider taking longs if the price action is signaling a good timing too.

Blue dark area:

If you are long and you see blue dark area and price action also signals beginning of a pullback, then you take out something to reduce your exposure.
if you are on a strong supply area and you see blue dark area, then you consider taking shorts if the price action is signaling a good timing too.

Examples

This is weekly cotton chart with Money Managers’ index extremes overlayed.

Money Managers are large speculators in commodity market and we have to follow them.

With the appearance of a red dark area, it is highly probable to have a bullish correction and vice versa, with the appearance of blue dark area it is highly probable to have a bearish correction.

Another example for index extreme overlays, this time on S&P500 chart.

The index is based on Asset Managers who are the large speculators in financial markets.

Look at the red area indicating bearish sentiment. Every time we had Red dark area a bullish pullback begun due to short covering of Asset Managers.

Look at this example from Asset Managers in BTC.

Sometimes index extreme signals a reversal and sometimes it signals beginning of a correction.

The context and price action can help you to find out which one is more likely.

In the following two examples for Corn and Wheat markets, we have extreme in index for PMPU as hedgers in commodity market.
Heavy bullish hedging (dark blue areas) signals bottom of market and vice versa heavy bearish hedging (dark red areas) signals top of the market.
Market context and price action will help us timing our entries or exits.
Hedgers can create imbalances between supply and demand.

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