The “COT” report is published by the Commodities Futures Trading Commission (CFTC) each week & tells us the positioning of all Traders holding Futures positions. Remember, with each future contract there is an equal & offsetting Long & Short position – It’s a zero sum game. You want to know who is taking the other side of your bet.
What you will find is that it pays to know who is buying and selling. Let's now take a in depth look at these reports and the respective participants.
The CFTC releases 3 reports weekly:
The Legacy Report - which breaks down participants between "Commercial Hedgers" and "Non Commercial Hedgers." Commercials are considered to include the Industry end users and producers along with Banks, while Non Commercials are considered to be Traders & Speculators, including Hedge Funds.
Legacy Report General Observations:
A - Commercials are considered the "Insiders" and most knowledgeable as to the fundamentals of their business.
B - Commercials sell strength and buy weakness.
C - Non Commercials are considered to be trend followers that buy strength and sell weakness.
D - Commercials, Including the Investment Banks, can carry extreme positions and be wrong for months or years. They have very deep pockets, are in bed with regulators and politicians, and always have the FED to bail them out at taxpayers expense. So don't ever think you have them "cornered" or "trapped". They can and will outlast you in any war of attrition, so this is not something we want to engage in.
E - This report has data going back to the early 90's, so we have a much larger set of data for our analytics, compared to the Disaggregated + Traders in Financial Futures CFTC reports, which they began publishing in 2006.
F - The reports are released on Fridays, with data being updated as of the prior Tuesday's close. While this does represent a 3 day delay, this information is still extremely valuable as changing of position, or establishing a extreme position, is typically done over a period of weeks and/or months. The reports allow us to track the footprints of the elephants in the room.
The Disaggregated Report - The CFTC started publishing this in 2006 in an effort to increase transparency by segregating traders into 4 categories.
1) Producer/Merchant Category – These are Commercial Traders who deal in the cash market and use Futures to offset their risk. If you are in the business of producing a commodity, such as farming or a mining firm, you are going to want to know what price you’ll be selling your product at. This group will “sell forward” their production, knowing what their costs are, as well as the sale price; essentially locking in their profit (or minimizing loss). Simple enough.
If you are in a business that requires consumption of a commodity on a large scale such as a food processor, airline, or oil refinery, then you are potentially exposed to rising input costs and want to minimize that risk to your business -Therefore you will go Long Futures (buy the commodity) and lock in the price.
In summary, the Prod/Merc category represents Large Corporations / Business concerns that deal in the production or consumption of raw commodities. They tend to understand very well the fundamentals of the business they are in, which include both the supply & demand of the commodities related to that respective business. You better believe they are paying top dollar to very smart people to help them manage this risk. This is one of your opponents when you step into the trading arena.
2) Swap Dealers - These are Market Makers/ Financial players who go Long or Short futures and then swap that exposure to another institution for a fee or other income stream. So who would they be swapping this exposure with? One example is pension funds who aren’t permitted to buy futures directly, but may want exposure to a basket of commodities in order to hedge their portfolio.
Who exactly are these guys though? Well, it’s JP Morgan, Goldman Sachs, Citiibank, Standard Chartered, Morgan Stanley etc etc –
When going to war, you better believe you want to know what these guys are doing. They are the shrewdest and best capitalized players at the table.
3) Managed Money – Exactly what it sounds like. These are hedge funds, commodity pools. They are typically trend followers & you will usually see them on the opposite extreme against the commercials at market turn points.
4) Other Reportable – This is every other trader that has a position that is large enough to qualify as a “reportable” but does not fit the first three categories. We can refer to them as large speculators – Maybe you one day?!
5) Non Reportable – Small specs whose positions don’t qualify them as reportable.
The last report is the "Traders in Financial Futures" or TFF report.
The TFF report divides the financial futures market participants into the "sell side" and "buy side". The following explanation is taken directly from the CFTC explanatory notes. The participants are broken down as follows:
1 - Dealer/Intermediary These participants are what are typically described as the “sell side” of the market. Though they may not predominately sell futures, they do design and sell various financial assets to clients. They tend to have matched books or offset their risk across markets and clients. Futures contracts are part of the pricing and balancing of risk associated with the products they sell and their activities. These include large banks (U.S. and non-U.S.) and dealers in securities, swaps and other derivatives.
The rest of the market comprises the “buy-side,” which is divided into three separate categories:
2 - Asset Manager/Institutional- These are institutional investors, including pension funds, endowments, insurance companies, mutual funds and those portfolio/investment managers whose clients are predominantly institutional.
3 - Leveraged Funds.- These are typically hedge funds and various types of money managers, including registered commodity trading advisors (CTAs); registered commodity pool operators (CPOs) or unregistered funds identified by CFTC. The strategies may involve taking outright positions or arbitrage within and across markets. The traders may be engaged in managing and conducting proprietary futures trading and trading on behalf of speculative clients.
4 - Other Reportables- Reportable traders that are not placed into one of the first three categories are placed into the “other reportables” category. The traders in this category mostly are using markets to hedge business risk, whether that risk is related to foreign exchange, equities or interest rates. This category includes corporate treasuries, central banks, smaller banks, mortgage originators, credit unions and any other reportable traders not assigned to the other three categories.
Analyzing the COT
OK – So now you know what the COT is, and you know the category of traders in the COT – you know who your opponents are, and hopefully you understand why it’s important to track this information. But how does 3ptCapital use the COT? How are you going to use it? Well, I’m glad you asked.
Each week after the release of the CFTC report we receive a data download and run it through our analytics model. In our studies of Decades of COT reports and associated price behavior, we've identified certain patterns which forewarn us of pending turn points. We developed a proprietary scoring scale which factors the Participants positioning and activity, in relation with price movement and respective volatility during that period. We then score this, represented as a "Relative Strength" over that defined period.
The end result is a scoring system presented in heat map format that will highlight to us, and you, when Commercial and Trader positioning, as well as activity, is at a Historical Extreme on a relative basis. We score their net positioning on a 18m and 5yr basis, as well as scoring their weekly activity and 4 wk activity.
Once we have these scores we are able to analyze historical price distribution given that particular setup using the Alchymist query table. Often market analysts or traders will reference the COT activity for the week, incorrectly assuming that this action is confirming their market bias. By measuring price action given specific COT setups, we know whether it foreshadows a bullish or bearish move.
The simple fact is that Historically certain market participants have a distinct advantage trading particular markets. One shouldn't assume that Commercials are always right or funds are always right - Reality is that it will be different for each and every market that you trade.
Further, it is important to understand that this information in and of itself is not a trade trigger; Rather it is considered a setup, or one piece of the puzzle.
Remember, we are looking for consensus across multiple indicators, or a state of technical "Unity".
For example, a trade scenario looks something like this:
We start with a fundamental thesis that Indian Gold dealers are stockpiling gold for wedding festivals in September. We are reading that rains were good this season so farmers will have money to spend, and India is known for it's inelastic Gold demand. Our Seasonal Odds tables support this assumption by showing us that the month of August has a 76% win rate over the prior 16years with the Average monthly gain of $42 exceeding average monthly losses of $33 - So the odds are certainly favoring a long position.
Gold has been weak the preceding 2 months & our COT reports are showing that Hedge Funds & Specs have been pressing their bets, amassing a short position which scores a 8% on a 18m basis, and 12% on a 5yr basis. We know these funds are trend followers, so once the trend starts to turn, they will unwind their massive short position and return to a neutral positioning.
We check the Alchymist query table to see price distribution for every instance Funds had a Net Position Score of 8% or lower. We see this setup has triggered 61 times from 2012-2018. We see that the 80th percentile price movement is $20.60 up vs (11.50) down given the setup for Bull/bear odds of 2-1.
The final step is the trade trigger which can be a signal generated from our Channel report or Pivot Trend Report, among other triggers we will discuss later.
Once you get a signal to buy, you place your order, and now your job is to manage your trade throughout it's lifecycle.
A key attribute of our COT reports is that by monitoring the extremes in activity, it notifies us that the Relative Strength Scoring of Net Positioning of the participants will be changing as well. So before a Commercial Net Position RS score hits 90% or higher, you will first see Weekly Change and 4wk change scores in the extreme range - So this is a forewarn of a indicator that then forewarns us to a pending turn in the respective market.
Once the Net Position RS score reaches an extreme we now have the proverbial fuel to rocket price in a given direction.
The COT Reports in Alchymist are a setup tool that alerts us to trades with excellent potential.
The core principal being that Trader Positioning, just like underlying Commodity Price, ebbs and flows from a state of extremes, to neutral levels. It's during this reversion to the mean in positioning that we can capitalize and profit.
The Alchymist COT reports are updated each Friday night after midnight EST. Take the time each week to review these reports and see how the big players are positioning. We do all of the aggregating and analytical work for you so that you can focus on interpreting the information.
Over time you will come to understand the power behind this technical indicator, provided it is used properly.
Remember, it's a set-up, and price rules supreme in this game. So you must wait for price action to trigger your trade entry, and then still respect the potential risk by monitoring your exit points vigilantly as well as via hedging techniques.