Wekelijkse rapporten
16 december 2021
Een interessante spreiding over metalen
12 januari 2022
Over the last few weeks, I have been very busy writing my latest book and have been neglecting everything else, including trading. I am making up for the lost time by updating the website and answering mail. In particular, I have received messages and questions about the COT, especially about how it should be interpreted.
With this article, I would like to respond to the people who have written to me and to all those who have doubts about how to use the Commitments of Traders (COT).
One of the most important aspects concerning commodities is to see and know how the positions held by financial institutions (those who speculate in the market) and operators (those who work with a commodity and access the market for hedging purposes) are divided.
This is made possible by the Commodity Futures Trading Commission (CFTC) which every week (usually Friday) releases a report, the Commitments of Traders (COT). The report shows market data for the previous Tuesday, so it is slightly delayed, but this is not a big problem.
The report shows, for each commodity, the long and short positions held by each market participant, as shown below:
- Producer/Merchant/Processor/User: an entity that predominantly engages in the production, processing, packing, or handling of a physical commodity and uses the futures markets to manage or hedge risks associated with those activities.
- Swap dealer: an entity that deals primarily in swaps for a commodity and uses the futures markets to manage or hedge the risk associated with those swaps transactions. The swap dealer's counterparties may be speculative traders, like hedge funds, or traditional commercial clients that are managing risk arising from their dealings in the physical commodity.
- Money manager: for the purpose of this report, is a registered commodity trading advisor (CTA); a registered commodity pool operator (CPO); or an unregistered fund identified by CFTC. These traders are engaged in managing and conducting organized futures trading on behalf of clients.
- Other reportable: every other reportable trader that is not placed into one of the other three above categories.
In the figure below you can see the corn COT taken on 7 December 2021 for futures only in the short format. The CFTC also releases a long format and a version where it aggregates futures positions with options positions.
All entities in the COT, therefore, are required to report their positions if they exceed a certain number of contracts called the Reporting level. The Reporting level is set by the CFTC and is updated over time.
Small traders and investors do not have to declare their positions as they are very unlikely to exceed the levels seen above.
Now, the breakdown of subjects that you have seen is what is known as disaggregated. There is also a "version" that aggregates the four subjects into just two as follows:
Commercial = Producer/Merchant/Processor/User + Swap dealer
Non-Commercial or Large Traders = Money manager + Other reportable
- Commercial are the real experts. They know the real value (price) of raw material, the actual supply and demand, and any problems. They move against the trend, buying on the lows and selling on the highs.
- Non-Commercial or Large traders (banks, hedge funds, Commodity Trading Advisors, etc.); trend followers who use futures as speculative instruments for pure profit.
- Nonreportable Positions. Small speculators who do not hold a position large enough to be reported to the CFTC. They tend to follow the Non-Commercial.
Below you can see the same corn COT taken on 7 December 2021 seen above but in the Legacy (aggregate) version.
Let us now see how to read and use the COT.
Regardless of the type of report used, the number of long and short contracts is shown for each category. In this way, you can immediately see whether operators tend to be bullish or bearish.
Spreading and Spreads report the number of the contracts held in spread. That is those positions balanced created with the purchase of a futures contract of a commodity and the contemporary sale of another futures contract on the same commodity but with different delivery (expiration). Therefore, it is easy to realise that the figure only reports Intramarket spreads (for those not familiar with spread trading, an Intramarket spread is created by buying and selling futures contracts of the same commodity, but with different deliveries).
Changes from shows the change from the previous week's report.
Percent of Open Interest Represented by (FOR) Each Category of Trader reports the percentage of open interest held by each category.
The number of Traders in Each Category shows the number of traders in each category. A point of clarification is in order. As also reported by the CFTC, the number of traders in each category generally exceeds the actual number of traders in each category since spread traders may also be present in long and short positions.
The total open interest reported, since each long position corresponds to a short position, is obtained by adding up the long or short positions in each category, as you can see in the example above with the corn:
Open Interest Long = 482,428 + 157,271 + 663,484 + 127,218 = 1,430,401
Open Interest Short = 71,614 + 157,271 + 1,031,357 + 170,159 = 1,430,401
The same information can be found in the long format of the report, both Legacy and disaggregated.
As it stands, this information tells us little. It does not allow us to understand the real behaviour of the various market players. What you need to do is to put the data on a chart and compare it with the price chart.
Fortunately, you do not have to do this yourself, there are sites and software that offer these charts for free. Personally, I use the SpreadCharts app which, apart from being free, I think is the best for analysing a spread.
Okay, this is all interesting, but how do I use this information in my trading? Mistakenly from what people think, the COT is not something that gives signals to buy or sell, but only gives indications of the sentiment of the main market players, often anticipating trend reversals. Therefore, the COT must be interpreted and evaluated together with price trends and other important data.
Another important aspect, from my experience, is that COT is not of the same importance for all commodities. I only use it for grains and softs. I also take a look at copper, as it is one of the non-ferrous metals that the investment company I work with deals with a lot, but for the other commodities I tend to ignore it. You can get a confirmation about this by looking at the COT of gold or natural gas.
So, to answer some of the questions I have been asked, the COT is another string to your bow, one more aspect to add to your analysis, but do not treat it as the Holy Grail. You need to evaluate it along with open interest and compare it to price movements.
To conclude, let me show you a couple of ways in which the COT gives me likely trend reversals.
Excessive buying/selling. There are levels of the net position above which we have an excess of long or short positions. Excesses can continue for several months, so the fact that the net position is above or below certain levels tells us nothing other than that the underlying is heavily bought or sold. Only a return to more normal levels provides a signal of a probable reversal of the trend.
For the sake of clarity, I will show you an example; below you can see the chart of the last 20 years of coffee. At the top is the COT with the net position of the Speculators and at the bottom is the continuous chart.
First, the net position is the long contracts minus the short ones. Then, as you can see, I have drawn two horizontal lines, one blue support (-20K), one red resistance (40K). Occasionally the net position falls below support or rises above resistance, which means that the Speculators are strongly bearish or bullish.
In these situations, it is not at all advisable to open positions trying to find a level where the trend can reverse. The probabilities to go against a strong loss are elevated. Instead, you should wait until the net position rises to at least -15K, after falling below the blue line, or falls to at least 30K, after rising above the red line, before opening a trade.
These levels obviously vary depending on the commodity.
Divergences. Another aspect that gives me a wake-up call is the divergence between price and net position. It means that the strong hands are losing interest and that it is very likely that we will see a reversal of the price.
You can see an example below with soybeans.
The price of soybeans continued to rise sharply during the descent of the Speculators' net position, which makes it very difficult to know when the trend has started to reverse. In these cases, it is not possible to set rules, experience and knowledge of the commodity and the general market situation count for a lot.
This then is the Commitments of Traders (COT). Probably some of you will have been disappointed, expecting something different, easier to use with clear signals. Unfortunately, this is not the case. The COT is an important piece of data, but it has to be evaluated, interpreted and then put into a bigger context, that of the analysis you are doing.
