Follow the Smart Money / COT Analysis

Am I right in assuming that you are a position trader.. you look at the week's COT report. ... enter a position when you see the extremes...(obvisouly in the same direction as the commercials).... wait a few weeks and collect profits?

I use the Classic COT report and I trade on a longer time basis (few weeks or even months). I don’t think that COT analysis would be as useful for shorter term trades, for day traders.

You are correct that at extremes, usually the Commercials are the ones that should “lead the way”, but there are occasions when they are “wrong”: I’ve read about it at the service I mentioned, it is called “Commercial Capitulation”, let me quote what they said about it:

Commercials hedge the most when they believe that the actual price is very favorable for them to hedge their future production. While they have an information advantage, they still cannot know the future. Sometimes, major shifts occur, that forces Commercials to unwind their hedge positions. Since they generally have deep pockets, their stress barrier is high, but not absolute. As the losses grow to critical levels on their trading accounts, they have to liquidate: buy back short contracts or sell the longs. These trades further fuel the steep price moves that caused the unfavorable situation, so the positive feedback loop leads to parabolic price rises.

It happens very rarely, but I think it is good to know about it when you look at an All Time or close to All Time extreme situation, where you are thinking of a big trend reversal… it not always happens!

I’m attaching the cotton example here, but on a longer, five years chart. I have indicated with a red line the place, where there was a very large COT extreme case, Commercials were at roughly 70000 contracts short, so at the time one could have thought that it’s a good short opportunity… Well it turned out that it was one of these cases and prices just skyrocketed from there.

In general I would suggest anyone interested in this report to try and implement it in their existing system, either by using it as a confirmation tool – there system comes up with a trade opportunity, check it with the COT report – or as a signaling “device” that will show you markets that have trading opportunities, but for exact entry and exit strategies you should use other techniques as well.

It look easy, when you look at the charts I’m posting, but in reality sometimes it could be pretty frustrating to wait for the price to react to the signal.

One thing is for sure, the COT report can effectively measure the stress level of a market and that can definitely give you an edge in trading.

Yep I can see how even they can get it wrong. What timeframe do you use on the COTbase site?

3 months doesnt appear like it gives you enough information.. 1 year is just 'boring' hahaha.

Do you have favoured instruments or do you trade anything that has an extreme?

Are you a fulltime trader?

I use the one year chart to look at the larger COT changes, but for Extremes I like the longer 5 year charts. Unfortunately you can't view longer charts yet, but I've contacted them about this and received the reply that they are working on it...

I have some favorites, but I trade any market where I find a solid signal and my system allows me to enter the trade.

Unfortunately I do not have the capital to be a fulltime trader, but I’m working on it!

I 've just signed up and ite pretty awesome... You'd need deep pockets to trade use this system..

I am looking at the dollar index.. commercials have been short since last november, but the index has rocketed from 77 to 84. They are still short now, but not as much as before, but still significantly short. I am also surprised why commercials would be long euros, given the economic uncertanties (i am probably surprised because I would be deemed as the dumb money).

So at what stage do you decide to enter a trade?

Yeap, I also think that this service is great!

I like those situations when the picture is extreme from all angles, and there are close stop levels that give me a good risk/reward trade. Obviously I diversify my portfolio amongst more markets and I take different risks depending on how strong I see a specific signal.

To give you an example, I might use tighter stops on the Cocoa market if I went short, while much further stops on the Wheat market. This is so because the large COT change in Cocoa market should have an effect on prices shortly or else I get stopped out soon, but on the Wheat market I’m not sure whether this is the top or not… it’s a more difficult question. For the past three weeks the COT was signaling an extreme, but still prices moved higher.

It always depends from the specific situation and of course your own strategy that determines how you enter a trade.

Am i correct in assuming that the commercials are not actually active traders themselves.. all they are doing is allowing the speculators to take positions off them.. is this correct? I find it quite strange that commercial traders would be doing to TOTAL opposite of specs... instead of look at fundamentals or technical analysis.

Hi Viv108,

(sorry for my late reply, was enjoying the weekend )

I believe you are correct in the assumption that Commercials are not trading in the same fashion as Large Speculators, but I don’t think it necessarily means that they are not as active.

One must understand that for Commercials, the futures markets provide a hedging opportunity which is the main reason why they trade. They need to hedge the risks for their normal businesses. An airline company might buy energy futures when they feel that the prices are low… let’s say that Delta buys Jun2013 contracts of Crude Oil for 95.52/contract and by the time of contract expiry the price of Crude Oil goes to 115.52/contract (that is $20.000profit/contract). This means that the fuel they need for daily operations most probably goes up --> their costs go up, so the profit the company is making would go down (unless of course they raise the ticket prices… but for the sake of the example, let’s say all other parameters are fixed). What happens is that the profit they made on the hedging activity compensates for the losses they have to endure from the increasing fuel costs.

I hope that my example clarified that Commercials really use the markets for hedging purposes and not for speculation. They are getting rid of risk, while Speculators are taking that risk. This is how the futures markets are working in a nutshell .

Have a great day,
Dunstan

Hi everyone,

Let me share with you the link to the latest Commitments of Traders review!

I would like to start with Wheat, since I was talking about it the last time already.

As the attached chart shows, nothing really changed in the picture since last week, we are still at an extreme in the COT, which – studying the past similar cases – seems to be a good short opportunity. Of course I know that some of you might want me to give exact entry levels, TP levels and stop levels, but instead I would just recommend you to have a look at other posts in the forum, where they might talk about systems, strategies that can offer a tool for such a situation. All I wish to highlight here is that Wheat is a market these days/weeks, where market participants are holding positions that are extremely long/short compared to their history. This is sort of a bubble that will burst sooner or later and it is advised to have one eye on it these days…

Live Cattle I think is also interesting. It was mentioned in the review, because Commercials changed their net position, further increased it by 16%. It is interesting really that Commercials and Large Speculators are both net long, while Small Speculators are the only ones net short in the market.

Of course as said in the review, a lot of Small Speculators are actually Commercials, they just don’t reach the so called “reporting limits”. If you look at the chart of Commercials and Small Speculators, you should see that the two lines have a strong correlation.

Looking at the picture, I would say that it is bullish, so if you were already long this market, you might want to stay in or if you were thinking of going short, this might not be the best time for that.

I am also open to discuss any particular market that you are interested in if you have any.

All the best,
Dunstan

HI again Dunstan - thanks for taking the time out to clarify it for me. That example has made things absolutely clear!!!!

So still it is apparent that the commercials have no interested in making money... they just want to protect themselves from a loss due to the moving prices. They dont take on a position because they 'know' which way the market is heading.. its just a pure coincidence that everytime they are extreme in a market direction, the market turns in their favour (usually).

No problem, just let me know if something is not clear!

Have a great day,
Dunstan

Hi everyone,

The latest Commitments of Traders review is out (here)

The first market that was mentioned, was Lumber, where there was a larger than average change in Commercials positions. The longer, five year chart shows us that neither commercials nor large speculators are at extreme levels, it is only small speculators, who seem to be extremely optimistic about the market (COT Index at 99%).

The size of the change in positions is definitely large enough and this coinciding with extreme optimism from SS is not a bad combination for confirming a bearish trade.

Sugar was the next market. I think this could be another good example we can use to understand COT analysis better. If you look at the 5 year chart, it is clearly visible that there was a shift in the short term trend a few weeks ago, we have moved away from the relative COT extreme and there is plenty of space left to reach a new COT extreme Buy signal. The example illustrates well that we should be careful how we view a COT change signal during a trend. I believe – agreeing with the COT review – that this signal should not be taken seriously and the down trend can continue.

I will be showing some other markets shortly, meanwhile if you would like to check out the recent COT report on other futures markets, you can do so at this service that I’m also using.

Let me know if you are interested in any specific market, I’ll try to analyze it for you!

All the best,
Dunstan

Sugar charts

More... More... very interesting..

Thanks a lot for sharing your knowledge. Just started to be interested in the subject. I just bought Larry Williams book " Trade Stocks & Commodities... Secret of the COT report"

I'm interested in the EuroDollars and USD index as I trade EurUsd pair

Martin

Hi Dunstan - would it be a good time to begin opening up a shirt position or two in the US indices? I am interested in the Nasdaq and the s&p500.

Hi arjfca,

I’m glad that you are so interested about the COT report and that you have already bought a great book about it! There is a great list of relevant books here, if you were looking for more.

If I was trading EUR/USD, I would be mainly looking at the EUR and secondly the USD Index. Actually, at the service I’m using, they have constructed the so called “True USD Index”. They combined the individual currency futures (the ones in the basket of USD Index) that have a lot more open interest (ie. analysis value) than the USD Index on its own. I believe the way they have done it is by calculating the exact dollar amount of how net long or short the given trader group (commercials, large speculators, etc.) is in case of each currency and they weight in the currencies according to their open interest dollar value.

Looking at the EUR -->
The last COT Extreme Buy signal had basically no effect, Large Speculators are still net short so until we see a new COT Extreme Buy signal, I would say that the down-trend should continue.

Looking at the USD Index -->
The past couple of COT Extremes couldn’t push prices lower, but Commercials and Large Speculators are still close to their Extremes.

Conclusion: Strictly looking only at the COT report, I would say that EUR/USD has larger chance to further decline for next few weeks, until we get a strong Buy signal from the report.

Hi Viv108,

Unfortunately in my experience, amongst all market categories, it is the Indexes where I find the COT analysis the least effective.

You can find some sort of correlation between extremes in the COT and the price, but not as strong as in other markets, thus the effectiveness of these signals on Indexes is definitely weaker – in my experience.

All the best,
Dunstan

sorry, the charts...

And here is the 5 year chart on USD Index

Hi Dunstan,

not to take away from your way of using the COT info, but I must agree with Custos.

The COT report only shows exchange traded open interest, be that futures or options, whereas the bulk of the fx market, in particular for large players, is OTC. So you may get a skewed picture of what's going on.

The COT is quite useful to forex traders especially when observing market reversals. However, it is still better to study and even do some back testing on COT reports and incorporate the trader's own feelings of what may actually work. After all, what really drives market prices are the peoples reaction to reports such as the COT, on politics and the economic movement. What is best is to use the COT, or other tools such as the Fibonacci numbers and the Stochastics, and combine it to what is actually happening in the world. This way, the trader may be able to gain an insight of the markets probable movement and may be prepared to do something about it.