We analyze the positions of major market participants

Achieving a statistical advantage by understanding capital flows is an important concept for trading success. Assessing investor sentiment and tracking the smart money will give you the confidence you need to generate consistent returns.

Commitments of Traders (COT) report analysis is a tool that can help you determine where the smart money is investing their capital. By assessing the information contained in this report, you can determine the trend in smart money risk positioning as well as prevailing investor sentiment.

COT reports, published each week, will give you insight into where major market participants, small speculators, and commercial producers are positioned in nearly every futures category. The report is distributed by the Futures Trading Commission and is published every Friday. This report has been published since 1986 and includes several financial instruments, including a report called the COT report for currency.

What are COT reports?

The COT Reports (also known as the COT Index) are published by the Commodity Futures Trading Commission. The CFTC is an independent agency of the United States that was created in 1974. The CFTC initially focused on agricultural commodities that had been sold in the United States for over one hundred and fifty years and had been federally regulated since the early 1920s.

In the 1970s, futures trading quickly expanded beyond agricultural products to include many other financial instruments, including:

  • foreign currency
  • government securities of the United States and other foreign countries
  • US indices
  • foreign shares

In late 2000, Congress renewed the CFTC’s mandate and passed the so-called Commodity Futures Modernization Act (CFMA). The Commodity Futures Modernization Act was a joint regulatory effort between the Securities and Exchange Commission (SEC) and the CFTC.

In 2003, the size of the swaps market increased dramatically compared to their introduction in the late 1970s. The Dodd Frank Act, which was passed in 2010, expanded the CFTC’s oversight of the swaps market to help more tightly control disorderly trading.

What are the responsibilities of the CFTC?

One of the CFTC’s primary responsibilities is to promote efficiency along with competitiveness in the futures markets. In addition, the CFTC is a watchdog that strives to prevent fraud, manipulation, and abusive trading practices in the futures markets. Like the SEC, the CFTC does not directly regulate the security of individual organizations. COT data is obtained by the CFTC for markets that have 20 or more traders with active positions.

The COT report is a powerful analytical tool because it offers updated information related to each futures market. In addition, the COT report is readily available for the most frequently traded futures contracts. For example, the COT report is available for currency contracts, which allow you to analyze COT in currencies. The information released by the CFTC is somewhat cryptic, which makes learning to read a COT report less straightforward.

The example shows that managed money increased the short position in futures and options by almost 38 thousand contracts, while at the same time reducing the short position in futures and options by just over 14 thousand. The total open interest in managed money is 151,094 long futures and options versus 216,366 short futures and options.

It is important to distinguish between the different groups of traders who use the COT report:

  1. commercial traders or swap dealers
  2. managed money or non-profit traders
  3. traders without reporting

As a rule, the largest positions are occupied by commercial institutions or so-called hedgers, whose goal is the delivery of goods. A good example of a commercial trader would be a soybean farmer who wants to hedge the price of soybeans to ensure that they can sell their soybean inventory at a certain price.

The second largest group are large speculators, who typically consist of hedge funds and trading pools. The positions taken by this group are speculative in nature, and these traders generally do not intend to take delivery of the underlying commodities they trade. This group trades for profit, and its movements can help you determine the underlying trend in a particular capital market.

The last group is considered to be small speculators. This group of traders takes up a small part in the overall market movement.

There is a term often used among commodity traders and that is “following the smart money.” What does “smart money” mean or who is “smart money”? By studying historical COT reports, you can see where the major players are positioned. This will help you stay on the right side of the market.

How to evaluate futures and options trading positions?

COT reports are a unique analytical tool and can be used by traders in many markets. They cover the most actively traded futures contracts: currencies, interest rates and stock indices.

Each week when COT data is released, you can analyze the report by plotting a graph or chart of the data. The data is available on the CFTC website and posted directly on the website’s home page – https://www.cftc.gov. It should be noted that the COT data released by the CFTC is not easily analyzed and is compiled into a text file when released.

As already mentioned, there are three groups of traders who prepare the COT report. These groups are commercial, large speculators and small speculators. While it is important to keep a close eye on commercial speculators, the column that a trader should watch first is large speculators. Commercial traders typically hedge and position themselves in the opposite direction of large speculators.

Additionally, changes in long or short positions can alert the trader to investor sentiment. If a trader sees that long positions have decreased since the previous week and short positions have increased, this indicates a decrease in bullish sentiment.

Market sentiment in general is very important when monitoring the futures markets. When looking at futures market sentiment, you should focus on the commercial trader or hedgers, as well as the non-commercial or large speculators. Small speculators have nothing to do with market sentiment. Understanding market sentiment can help a trader predict potential price movements.

Farmers are one of the largest groups that rely on futures markets to reduce their risk. They are in the business of growing crops and there is no certainty that the price of the crop they grow will increase in value. Thus, if, for example, a farmer grows soybeans and there is a risk that the price of soybeans will decline, the farmer hedges his risk by selling a soybean futures contract on the CME Group exchange.

There is always a possibility that the price of soybeans will increase during harvest. If this happens, there is a good chance that the farmer will make a huge profit from his crop. However, the opposite may occur and the soybean process will move lower, resulting in significant losses for the farmer.

Market Sentiment Indicator

The Market Sentiment Indicator attempts to measure the overall bullish or bearish sentiment in the futures market. Market indicators can lead or confirm overall price movement. In addition, indicators can track investment behavior associated with smart money.

The weekly data obtained from the COT report is very useful, but it is not easy to analyze. It is much easier to view COT data through a graph that will display historical data. There are many free applications from which you can download COT data. Alternatively, a trader can create his own COT charts, but this takes much more time.

Using the COT report, you can use it in the same way as a regular technical indicator, which only analyzes price and time. Filters can be applied to the report to give the trader a better understanding of whether traders are becoming bearish or bullish. With this knowledge, the trader has the ability to initiate an exit or entry into a trade.

As noted earlier, the term “following the smart money” is often used among professional traders. By studying historical COT reports, you will see where the major players are positioned in the market. Studying COT reports will help a trader be on the right side of the market and increase his chances of success.

On the chart of the British pound, you can see when the major players began going short in January (blue line), which foreshadowed a decline in the price of the futures contract.

Hedging in the futures market

A commercial hedger is an entity that typically produces a commodity, or an entity that will need to purchase a commodity in the future. These groups seek to limit or reduce their risk by taking advantage of hedging in the commodity markets.

Farmers are one of the largest groups that rely on futures markets to reduce their risk. Farmers are engaged in growing crops, and there is no certainty that the price of the crop they grow will increase in value. Managers in a large corporation will also hedge currency or interest rate risk using futures.

Hedging has two parts. The first part of the hedge is the position in the commodity that is to be purchased. The second part of a position in the futures markets is a hedger’s position to reduce risk. Usually one of the positions is biased in favor of the hedger and the other is biased against the hedger. In an ideal example, the hedge’s distribution will remain the same over the entire time period.

There are times when an organization or industry may not be able to hedge. A great example of an organization or industry not being able to hedge is when the price of oil has risen dramatically. Airlines suffered huge losses and some went bankrupt due to high fuel costs. If companies had properly hedged their risks, most of their losses could have been avoided.

Let’s sum it up

COT reports are a valuable tool that traders can use to improve their understanding of price movements in financial markets. You can use the COT report to better understand what commercial hedgers, large traders and small speculators are doing in the commodity markets.

The Commodity Futures Trading Commission, or CFTC, is the body that produces the COT report. One of the most important roles the CFTC plays is to ensure that commodity markets operate efficiently and that players in the futures markets do not manipulate markets or engage in fraudulent activities.

One of the most important elements of a COT report is its ability to help commodity traders see trends in the market. By actively monitoring the COT report using charts, commodity traders will have an idea of ​​the trends that are emerging in the commodity markets. Analyzing COT reports will benefit the individual trader and give him a better understanding of the direction of a particular market.

Additionally, market sentiment will help the commodity trader make better decisions regarding the direction of the markets. The groups that commodity traders should focus on are non-profits or large speculators. This will help the trader track the smart money and better understand when to enter or exit the market.