cot index indicator
DESCRIPTION
COT to trade futuresTRANSCRIPT
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HOW TO USE THE COT REPORT FOR
TRADING
BY ALEX BERNAL
With much of the commodities space taking a hard tumble in recent weeks. I
wanted to showcase a very useful tool that I use in my commodities analysis
and trading: The Commitment of Trader Report.
Every Friday the Commodity Futures Trading Commission or CFTC is kinds
enough to issue a report that aggregates all the futures positions of every
major player in the futures markets.
http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm.
The aggregate data is broken down into different commodity groups and by 3
Basic different types of traders.
1. Large Trader
2. Commercial Hedgers
3. Small Speculators
The Largest positions are typically held by commercial institutions or
“hedgers” that have the indent actually taking delivery of the underlying
commodity. Commercials are considered the most knowledgeable & are the
most important group to keep tabs on.
The next largest player is typically the “Large Speculators, which include
Hedge Funds or CTA Trading Pools. These guys are much smaller than the
overall commercial positions and on average do not have the intent on taking
delivery of any of the under lying commodities they are trading. They are
trading purely for profit and their actions are often less valuable to watch
because they typically trade Future Spreads (Calendars) or Married positions
(futures + options).
The last group is call the Small Speculators or what some people call “dumb”
money. This group is considered the small guy or 1 lot crowd. It is also
typically seen that this group is the most ill informed and thus should be
“faded” or traded contrarian too. I have not really found this to be the case
but there are times when this group does reach pretty extreme readings.
Managed Money, Merchants & Swap Dealers are three new disaggregation’s
that have only been available in recent times that can further splice up the
Commercial and Large Speculator positions in to even more specific
categories. This is because of the growth in Commodity Index Funds or ETFs
that perpetually hold long positions in the commodity. (IE GLD or VXX)
See Chart Below
Large Trader – Purple
Managed Money Crimson
Merchant Red
Small Trader Black
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Swap dealers blue
So we get the data for free now what?
This was the first thought I had when I started trying to analyze this data. At
first glance it did not seem particularly useful in anyway because it was just a
snap shot of what traders DID not what they will necessarily DO next. But
the old saying “you can’t turn a tanker on a dime” does lay way to how the
commercial paper affects future prices in the commodity.
COMMERCIALS, COMMERCIALS, COMMERCIALS
It was only after studying the works of a few experts like:
1) Larry Williams
2) Steve Breise
3) Floyd Upperman
4) Jake Bernstein
that I fully realized one portion of the participants are FAR more important
to watch than the others: The Commercials. The Big Whales, The Deep
Pockets The Deciders. These are the guys that when they make moves you
will see the large scale ripple effects throughout the price of the commodity
in question.
As you can see in the below chart the Commercial activity is often in the
OPPOSITE direction of the markets trends. This is because they are actively
buying when the market is going down and actively selling when the market
is going up. They are the experts in their businesses they are often seen to be
acting many months in advance of where they believe the price will be. Now
this is not always the case and Commercials are not always a “sure thing” but
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they are the closest thing to a “predictor” that we can get. Also in the graph
below I have isolated only the commercial movement and the Movement of
Crude Oil over the last few years. It is very easy to see that the commercial
movement dominates the overall price trend of oil.
The COT Index
So in order to further make use of this data in a way that can help us
speculate on futures prices one common indicator that I want to show you
how to construct is called the COT index.
The calculation is below
COT index = 100 x (current Net – Minimum Net) / (maximum Net – Minimum
Net)
This indicator converts net futures positions to a 0% 100% scale
(normalizes). It now reflects where the current net positions rank as a
percentage of its range over the recent past data (typically three years). I use
this to watch for extremes reading in the commodities markets. A 90 %
indicator suggests there has been a commercial buying climax. A 5% percent
reading suggests a commercial selling climax. In short the COT indicator tells
me when the biggest most influential players are ALL IN either buying or
selling futures. This is not necessary a call to action but rather an illuminating
clue for possible trading setups. I never take trades merely on the COT data
or COT Index but rather use my usual execution tools to confirm a new trend
before I make a trade.
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The graph above is a great example of how the COT index shows when the
cocoa market was overbought or oversold in the last couple years.
Other COT Indicators
There are many other indicators that I have come across being applied to the
COT data, some include:
1) Spread and Rate of Change of the difference between Commercials
and Large speculators
2) Spread and Rate of Change between Swap Markets and Futures
Markets
3) Cycle Analysis on the COT raw data or COT index.
4) COT Index adjusted for seasonality
Drawbacks of this Data
1) IT IS LATE! After the fact! Be aware by the time you get this data it is
at least a week old and large speculators and commercials can and
do change positions quickly!
2) Markets can stay over bought and oversold for very long periods of
time. Just because a COT Index extreme is reached doesn’t
necessarily mean that the market will up and reverse right after if the
commercials do not commit to a new direction of accumulation or
distribution there will likely be no new trend change.
3) COT data does not account for possible “spreading” of positions. This
can skew the data slightly in particular markets where calendar
spreads are a large portion of the overall open interest.
Lastly I want to leave you with some graphs of current commodities markets
on their Current COT and Index Positions that I believe are at important
inflection points. Happy Trading
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GBP JPY
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SP500 DX
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GC Copper
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Coffee Natural Gas
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Palladium
Alex Bernal is a Chartered Technical Analyst with
many years of industry experience in the Equity,
Commodity, Currency, Interest Rate and Derivatives
markets. He appears on several media outlets,
including Bloomberg. Alex currently operates a
private technical research and trading systems
consulting company Aether Analytics out of Santa Barbara, California. You
can reach him at [email protected]