Risk-On and Risk-Off Windows

Everything in this system starts here. Not with a stock, not with a theme, not with a narrative. With the broad market itself. The regime tells you whether the window is open or closed. Every step that follows is downstream of that single read.

Why the Broad Market Comes First

There is a version of position trading where you find a great idea and buy it regardless of what the broader market is doing, trusting that the strength of the individual thesis will carry the position through any environment. That can work. It also requires a much higher tolerance for watching a correct thesis move against you for extended periods while the tide is going the wrong direction.

This system takes a different approach. Rather than fighting the tide, it waits for the conditions under which the market is most likely to reward a concentrated long position, then deploys capital specifically into those conditions. The broad market regime is the first filter, and nothing downstream of it matters until it clears.

The indexes watched are the S&P 500, the Nasdaq, the Dow Jones Industrial Average, and the Russell 2000. No single one of them tells the complete story. Read together, they provide a layered picture of where large-cap, growth, industrial, and small-cap participation stands relative to the structural trend. The Russell 2000 deserves particular attention because small-caps tend to lead both into and out of risk-off conditions more aggressively than large-caps. When small-caps begin showing early relative strength while the large-cap indexes are still below their averages and commercial buying is emerging in positioning data, that divergence often precedes the broader regime change by weeks.

The Moving Average Framework

The primary structural read on those indexes uses three moving averages: the one-year, the three-year, and the five-year. Each one answers a different question.

• 1-Year Moving AverageThe intermediate trend. It tells you what the market has been doing over the most recent twelve months. When price is below this average, the majority of participants who bought during the past year are underwater. This is the most sensitive of the three and the first to turn in either direction.
• 3-Year Moving AverageThe medium-term structural trend. It filters out shorter-term noise and tells you whether the weakness in the one-year read is a temporary deviation from a longer uptrend or a continuation of something more structural. A market below its one-year average but well above its three-year is a different situation from one that has broken both.
• 5-Year Moving AverageThe background structural trend. The frame within which everything else moves. A market below its five-year average is in a condition that occurs infrequently, marking either a genuine secular bear market or a significant cyclical dislocation that, once resolved, creates the conditions for a powerful recovery.

The risk-on window begins to open when the broad indexes are trading below these averages and the other signals described below begin to align. The further below these levels the market trades, the more compressed the opportunity set becomes, and historically the more aggressive the eventual recovery has been. The window being open does not guarantee the trade works. It identifies the environment in which this approach has historically had its best outcomes.

The COT Report: What It Is and Why It Matters

The Commitments of Traders report is a weekly publication from the Commodity Futures Trading Commission that shows how different categories of participants are positioned across futures markets. It breaks down open interest in any given futures market into the positions held by commercial participants, large speculators, and small speculators. The report has been published for decades and it is one of the few pieces of public positioning data that reveals not just what price is doing, but who is doing what behind it.

The reason it matters for this system is that different participant categories have fundamentally different relationships with the markets they operate in, and understanding who is buying or selling tells you something that price alone cannot.

Commercial Participants

Commercial participants are entities that use futures markets as part of running an actual business. Their participation is about managing the risk of their real-world economic activity, not about speculating on price direction.

In the gold market, commercial participants include gold mining companies that sell futures contracts to lock in a price for production they have not delivered yet, and large jewellery manufacturers or industrial users who buy contracts to guarantee supply costs. In the oil market, oil producers sell futures to hedge their production revenue while airlines buy them to lock in fuel costs. In agricultural markets, a corn farmer sells corn futures before harvest to protect against a price decline, and a large food processor buys corn futures to lock in input costs before prices potentially rise.

Because their futures activity is tied to an underlying business reality, commercial participants tend to accumulate long exposure when prices are low and reduce it when prices are high. They are structurally contrarian. They are not chasing trends. They are managing real economic exposure, which means their positioning reflects a view about value rather than a view about momentum. When commercial participants are aggressively buying into a downtrend, they are stating, through their actual risk management behavior, that current prices represent attractive value relative to their cost structure and forward expectations.

Speculative Participants

Speculative participants have no underlying business exposure. They are in the market purely to generate a return from price movement. This category includes commodity trading advisors running systematic trend-following models, hedge funds trading macro themes, and a broader population of discretionary speculators.

Because they have no underlying business forcing them to hedge at specific prices, speculative participants tend to follow trends. They buy strength and sell weakness. Their positioning is therefore procyclical: they accumulate long exposure as markets rise and build short exposure as markets decline. When speculative short positioning reaches historically elevated levels, it means the trend-following community has piled heavily onto the downside. Every one of those short positions is a future forced buy when the trend reverses. The larger the speculative short position, the more fuel exists for the recovery once the selling pressure exhausts itself.

The COT Proxy is a proprietary lookback-based tool that extends this read. Built with a different methodology than the widely known Larry Williams COT indicators but sharing the same intent: surfacing when the commercial buying signal is emerging even before it becomes obvious in the standard report data. It adds a timing dimension to the raw positioning read.

Volume Profiles on the Indexes

The moving averages tell you where the market is structurally. The COT data tells you who is positioned how. Volume profiles on the broad indexes add the third dimension: where has the actual transactional business been conducted, and what does that tell you about the structural integrity of current price levels?

The logic here is exactly the same as it is in the short-term playbook, applied at a larger timeframe.

Areas where a significant volume node has built represent levels where a large amount of business was done. Both buyers and sellers were willing to transact at these prices in volume. These areas have structural weight. When price returns to them, the participants who conducted business there have a reference. That is why high-volume nodes tend to act as structural support or resistance, and why revisits to those areas tend to slow or stall price rather than moving through cleanly.

Areas where price moved through quickly with minimal volume are structural vacuums. The market traveled through these prices but did not do meaningful business there. There was no real negotiation, just movement. These low-volume areas offer little structural resistance on a revisit, which is what makes them relevant for understanding where price is likely to accelerate rather than stall when it returns.

An imbalance that fails to break, where price pushes into a prior high-volume area and is rejected, tells you one of two things: either the bid is actively defending that level and absorbing the selling pressure, or the offer is no longer willing to step down with prices and the selling is drying up. Both produce the same price behavior but for different reasons, and in both cases the message is the same. There is structural support at that level that is holding.

Reading the leg-to-leg volume profile on the broad indexes during a decline tells you where the most business was conducted on the way down, which levels carry structural weight on the recovery, and where the low-resistance zones are that price is likely to move through quickly once the regime turns. That structural map becomes the framework for setting targets when the trade is constructed in Chapter 6.