How to use COT reports to trade market?
Various tools are available to traders for being successful on the Forex and Futures market. There are indicators that can be used for market analysis among these tools. Market sentiment indicators are one of the categories of extensions that traders often use. We will discuss in a series of articles about the use of some sentiment indicators.
So, what is COT itself? How to use COT on PTMC?
The COT Report, a strong sentiment indicator for traders
The COT, abbreviation for Commitment of Traders, is a weekly report provided by the U.S. Commodity Futures Trading Commission (CFTC) every Friday at 3:30 pm (Eastern Time). This weekly report reveals the net positions (long and short) of traders for Futures, but also for Futures-and-Options-Combined.
To obtain raw data from the COT report, you can visit CFTC website. The COT statistics are presented in tables as the one you can see below.
As well the same statistics can be presented in chart form:
As you can see from the image, the COT statistics indicate the positions of:
- Commercial Hedgers (Commercial) which take delivery of Futures instruments. They use the futures market to hedge against risk;
- Large Traders (Non-Commercial) who trade for profit. They are hedge funds, banks, and Commodity Trading Advisors. They mostly follow the trend of the market;
- Small speculators (Non-reportable) who are essentially retail traders and whose positions are not large enough to be reported in the above categories. Their positions are calculated by subtracting reportable positions from the open interest.
Statistics on the Open Interest indicate the number of contracts that are opened by traders for a Future. The Open Interest is therefore not the volume of market positions.
If you want to obtain COT report statistics in the form of more eye-pleasing graphics, you can visit this link. You will have access to graphics based on the COT’s Legacy Format like the one below:
In addition to the COT Legacy Format (which is the oldest) presented in the previous table, COT data are presented in other formats: the Traders in Financial Futures format (TiFF) and the Disaggregated format. The TiFF report concerns only financial futures, including currencies and stock indices. Disaggregated format informs traders about traders’ positions on commodities and metals.
The Traders in Financial Futures format (TiFF)
As you can see, TiFF format of COT report breaks down non-commercial traders into more precise categories.
As explained by CFTC:
- Dealer/Intermediary are large banks and dealers in securities and derivatives;
- Asset Manager/Institutional are institutional investors like mutual funds;
- Leveraged Funds regroup hedge funds and other large speculators;
- Other Reportables are any reportable positions that don’t belong to the above categories;
- Non-Reportable positions are the difference between the reportable positions and the open interest;
COT report in disaggregated format
The following table from CFTC show COT report on Gold in disaggregated format.
The categories on the disaggregated report are more discrete:
- Producer/Merchant/Processor/User who are producers and users of a commodity. They hedge against risk using the futures market;
- Swap Dealers deal in swaps for a commodity but uses the futures market to hedge against risk associated with their transactions;
- Managed Money from large speculators (institutional investors & funds);
- Other Reportable positions that can’t be put into one of the above categories;
- Non-Reportable positions that are calculated by subtracting the total reportable positions from the open interest;
Trading with COT report analysis and PTMC
Analyzing COT report allows traders to take right positions on the market. However, reports of each Friday are useless alone. It is rather the evolution over time of the positions of the different parties on the market that will indicate to traders the direction for their trades on the market.
In this section, we will discuss markets where COT is exploitable, the trading style that is appropriate for the use of COT, and tools that PTMC offers to use COT reports in your trading strategies. The majority of traders use the COT report Legacy Format to interpret market sentiment.
Which traders will find COT report useful?
COT data provides statistics on Futures markets, so, traders there can benefit greatly. However, as the Futures market directly influences Forex and CFD, Forex traders and those, who prefer CFD can also use these statistics.
As mentioned before, the COT reports come out weekly. Its indications concern the activity of the market on Tuesday preceding the publication of the report. Traders who prefer intraday or scalping will therefore not really benefit from the COT report. For this reason, the use of the COT data is advisable for swing traders who take positions on daily and weekly charts.
While trading with PTMC, you can screen the market’s opportunities with the following indicators which are based on the COT report’s data:
The Open Interest Indicator, a tool to detect reversals
PTMC offer the CFTC Open Interest Indicator with two display modes as shown in the screenshot below.
How to decipher the Open Interest? The Open Interest’s value diminishes when two traders - a buyer and a seller - close a contract, but increase when they create a new contract. Moreover, if you look at the chart below, you will probably notice that an increase of the Open Interest associated with a rising price is the typical behavior of a bull market. But if prices are bullish and at the same time the Open Interest falls, we are most likely facing a reversal of the bullish trend.
Analyze the market with the COT Report Positions Indicator
With PTMC, you have the COT Report Positions Indicator that can help you to analyze the market with success. As you can see in the image, there are numerous settings you can choose to deeply analyze traders positions for a Futures asset.
On the image below, you can see the COT Report Positions indicator on a weekly chart of Gold. It also shows the correlation between the price moves and traders' positions on the market.
When you want to use COT report positions in your trading strategy, you should keep in mind that:
- The "commercials" are the most optimistic investors in a bear market and the most pessimistic when the market reaches highs. They will then always use a hedging strategy to protect themselves. More clearly (as seen in the image above), this means that Commercials are often in the opposite direction of the trends. They buy when the market is bearish and sell when the market is bullish. Their strategies are the genesis of reversals and new trends. They’re in reality the big boss of the market;
- Larger traders (Non-Commercial) simply follow the trend. They are large speculators. When you look at the previous screenshot, you’ll notice that in a bullish market, they’ll be buying ‘till the trend reversals;
- The price moves are negatively correlated with Commercials positions and positively correlated with Large Traders positions;
- If all operators are already in the same direction (long or short), there is a strong probability of a reversal of the trend since there are no longer sufficient counterparts.
Let’s see another tool PTMC offer us to use COT reports, the COT Index.
How to use the COT Index indicator?
The COT Index indicator is a bit different from the previous tools we discuss. Created by Larry Williams and Steve Briese, this indicator helps traders to identify price extremes, and it can be used to locate possible reversals. The following formula is used to calculate the COT Index. As this formula show it, the COT Index converts net Futures positions to a 0% -100% scale (normalizes).
COT Index = 100 x (Current Net - Minimum Net)(maximum Net - Minimum Net)
It reflects the current net positions rank as a percentage of its range over the recent past data (26 periods by default on PTMC).
Let’s see what it look like on the following weekly chart of Gold.
How to interpret the value of COT Index? You should use this indicator to see what major players are doing on the market. For example, a 90 % (or more) index suggests a commercial buying climax where market bosses are all in buying. On the other hand, a 5% index suggests a commercial selling climax where they’re all selling. The previous picture of COT Index show clearly overbought and oversold areas where Commercials are all in selling or buying.
From the beginning of this article, we discuss how useful COT reports’ data can be for a trader. But I guess you wonder if there is any drawback of using COT reports.
Drawbacks of COT data and precautions to take
COT reports are really useful for swing and position trading. But remember that all data of COT reports are delayed. This means that all indicators based on COT are working slower and resulting later. So as the market can change fast as light, you should only use COT’s indicators as your analysis confirmation.
Moreover, even when you identify for sure an overbought or oversold situation on the market, that doesn’t mean that a reversal will occur fast. Prices can stay in overbought or oversold area for weeks or even months, depending on your charts’ time frame.
Another drawback of trading with COT analysis is that correlations between price direction and Commercials and Large Traders can sometimes break for periods of time.
In conclusion, keep in mind that while using COT report is really useful, you should not neglect the price action setup to be successful.
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