The Commitment of Traders Report (COT) is a very important tool for futures traders who are interested in spotting the big moves before they happen. This lesson examines the COT, its meaning, and my recommended applications. It should be noted that the COT report is not applicable to stock trading. If you only trade stocks you can skip this chapter. Let us look at the information that is contained in the COT report. The COT report is issued weekly by the United States Commodity Futures Trading Commission (CFTC).
The report contains a detailed breakdown of the total number of long and short positions and changes in positions from the previous weekly report. Various market information and advisory services analyze the COT data shortly after it is released on the last business day of each week. You can see the report and read about its construction and history at the CFTC Web site at http://www.cftc.gov. The best way to understand the COT report is by studying the position breakdown in three categories of traders: commercials, large speculators, and small speculators. The true value of this report cannot be ascertained unless you know what to look for.
Before we begin, I want to be clear that what you read in this lesson is my analysis, application, and understanding of the COT report. I say this because opinions about the meaning of the COT report vary from “useless” to “the Holy Grail.” There is no lack of controversy about the COT. You may already have formed your own opinion based on what you have been told or what you have read. I ask you to rid yourself of any other opinions, at least for the duration of this lesson.
To fully understand the COT, you must understand the role and the goal of each group. Let us begin with the “small speculator” group. What exactly is a small speculator, and what do small speculators do? The answers are simple. Small speculators are exactly what the name implies. They are traders who trade small positions (one to three contracts) and/or who have a relatively small amount of money in their accounts. To put things simply, which is the best way to look at things, small speculators are generally considered to be poor traders (unless they have taken my course or seminars or worked one on one with me in my Mentoring Program).
Prevailing opinion would have us believe that if we know what small traders are doing then we can make money by doing the opposite. I do not believe that this is true. If small traders always lost money, then they would not play the game. Furthermore, looking at the correlation of small trader net long or short positions with price trends does not, in my view, support such a conclusion. The chart below is merely one example of what I mean.
Note that the COT line plot at the bottom of the chart has a zero line. When the COT number is above the line it means that small traders are net long. When it is below the bottom line it means that small traders are net short. As the line rises, short positions are decreasing or long positions are increasing. As the line moves down, short positions are increasing or long positions are decreasing. See the notations.
As you can see from there was no consistent pattern other than the fact that small traders were net short soybeans for the duration of the bull market. In and of itself this information is, in my view, meaningless unless it is used with a clear and effective trigger. (Remember the STF model.) Another factor that limits the potential usefulness of the COT numbers is that by the time the report is available it is actually a week old. It cannot, therefore, be used for short-term timing.