Let's start by quickly defining what the COT report is.
Straight from the horses mouth:
The Commodity Futures Trading Commission (Commission or CFTC) publishes the Commitments of Traders (COT) reports to help the public understand market dynamics.
Specifically, the COT reports provide a breakdown of each Tuesday’s open interest for futures and options on futures markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC.
The COT reports are based on position data supplied by reporting firms (FCMs, clearing members, foreign brokers and exchanges)
Short version. It's a big old positioning report.
So you're telling me I'll know the positions of other market participants?
That's a HUGE advantage for me, like a cheat code or something!
Yes and no.
It only matters when it matters.
The COT report is most useful at market extremes, mainly when used together with other indicators/reasoning.
It's rarely enough to use as the sole reason for entering a position.
Let's start by looking at FX.
(The COT report isn't that useful for index futures or treasuries as it is impossible to distinguish speculative positioning from hedging)
If you take the data from the CFTC site, you'll find a horrific mess like this:
Your brain will pack its bags and leave for more colourful & interesting surroundings.
So, you can either take the data and feed it into excel yourself or find someone who has already done the work for you...
The report is divided into two groups:
- Commercial (large hedgers)
- Non-commercial (large speculators)
We're focusing on the large speculators because they'll usually have tighter stops and be more likely to unwind positions when the environment changes.
Put another way, speculators have one clear motivation, while hedgers may be engaging in more complex trade structures that are hard (or impossible) to decipher.
The COT report is often lazily spoken of as a tool to 'fade the crowd'.
When is it the right time to fade the crowd though?
At the extremes.
It's better to think of COT data as 'fuel for the fire'.
Imagine a market in a downtrend.
As the market meanders lower, shorts will be added most weeks and/or longs will be closed out.
The net positions will become more negative.
Sometimes the price goes up as net short positions increase, sometimes it goes down.
Not very useful for short-term traders.
Remember, it's already stale by the time it's released (Tuesday positioning is released each Friday).
However, it can be useful to track for when any big narrative changes.
Once the story/trade is over, those positions have to be closed out, which creates a clear directional market bias.
Most of the time the COT is more noise than substance.
There are occasions when it provides some wonderful opportunities...
In part 2, I'll show some examples...