cot index indicator

APRIL 2013 ATMASPHERE | 15

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

16 | ATMASPHERE APRIL 2013

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


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.


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


GBP JPY


SP500 DX


GC Copper


Coffee Natural Gas


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]

cot index indicator

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