How to Use the COT Report – A Comprehensive Guide
COT Report (Commitment of Traders Report) is one of the most relevant pieces of information when it comes to understanding the role that volume plays in Forex. It is published by the Commodity Futures Trading Commission and released every Friday, around 2.30 pm EST. But why do so many people speak about the COT report? In order to understand this general question we need to address four issues in this guide: why is it relevant, where to find it, how to understand the COT report and, finally, whether or not a trading strategy is possible with information extracted from the report. Let’s start with the first question.
Why is the COT Report so Relevant?
When we are trading any financial instrument some of us tend to be concerned with the role that volume plays in driving price. But how can I have a better understanding of this issue?
If in markets such as stocks the volume can easily be identified by everybody, in other markets such as Forex there is no day-to-day indication of the volume that is affecting the market. One way to understand this is, therefore, by looking at the COT report.
Forex transactions are normally made over-the-counter. And this essentially means that they are done on a daily basis and without the formal registration in one big aggregator of data such as the Chicago Mercantile Exchange of the real players and real investments involved. Without the collection of this information, it becomes almost impossible to accurately understand where the volume in the market is.
What the COT report allows is, therefore, for an understanding of this question. And this is so because its main purpose is to register what happens in futures markets. These types of markets are ones where traders need to keep their positions open for more than one day – so it becomes inevitable that entities that regulate this market understand what is affecting price volatility and who is affecting price volatility.
By having to keep their positions open for more than one day, traders in these futures markets allow us to understand where volume is.
Where to Find and Terminology: the Commitment of Traders Report Explained
There are two ways to find the COT: the traditional way and the modern one. Let’s start with the first one.
The official report can easily be found in CFTC website through this link.
Once the document is downloaded – look for Currency Legacy Report / Chicago Mercantile Exchange – Futures Only / Short Format – don’t be scared with the information. Just search for the particular instrument you want to look at and that’s it.
More relevant is to decipher some important terminology in this report. Let’s do it here then:
Commercial – These are big businesses that use the futures market to hedge against some other investment.
Non-commercial – Mixture of retail, hedge funds and financial institutions that play the game not to hedge but to win.
Short – Number of positions open that are selling futures contracts
Long – Number of positions opens that are buying futures contracts
Open interest – These are orders that were not yet executed
But even though we would recommend you to go through this traditional route so you understand all the terminology used and get a better grasp of what really constitutes the COT report, there is another way that you can use.
A simple indicator can be used to understand how the COT report is affecting different currencies. This indicator can be accessed on Finviz.
What is showed here are different currencies and the weight each type of trader has in these different currencies.
How to Read the COT Report?
Once we understand key terminology it’s time to address probably the most important section of this article: how can I read the information contained in the COT report? The report gives us important information about three main players that represent three main market positions.
Hedgers or Commercial Players – These are all those that aim to protect their positions in futures markets because they want to hedge against some investment made in another financial instrument. Their interest is not to make money but to hedge a particular position.
These are contrarian traders and the reason for that has to do with their own self-interest – for example, since they want to hedge a particular long position in a particular financial instrument, they understand really well when things can turn. Commercial players or hedgers are therefore bullish at market tops and bearish at market bottoms.
Large Investors. These are the traders you want to be following. They are the sharks of trading, and trade to make money on speculation. They also tend to add to their positions along the way – and this reinforces the powerful effect of the trend.
Small Investors – These are all those hedge funds or retail traders that own small trading accounts. The most relevant information about small investors is that they tend to be on the wrong side of the market.
They normally buy when the market is at the top of the trend, and sell when the market has no more room to go to the downside.
Is a Trading Strategy based on the COT Report Possible?
Can we use the Commitment of Traders Report for a trading strategy? Previously we have discussed three important questions regarding the Commitment of Trader’s report: why is it relevant, where to find it and how to understand the COT report and finally what is its main message for us as traders. The last important topic to address is the link between the COT report and trading strategies: can it be used as a tool to trade?
Like so many other indicators, the Commitment of Traders Report can, in fact, be used as a tool to trade if we fully understand – and read correctly – where volumes of the market are and where the different positions of the different types of investors that characterize this report are.
Having understood that this report allows us to identify three main types of traders –hedgers, large and small investors – we can use it in our trading in two particular occasions:
Reversals (Type One) – When the spread between commercial hedgers and large investors is big, then we should expect a market reversal.
This can easily be explained by understanding that large investors are normally accumulating their positions around key reversal points. When this happens this in and off itself is a sign of a potential reversal. If the spread between the Large Investors and Hedgers is high, and it reaches a peak, then it means that we are in a tipping point towards a potential reversal that we can catch in its infancy.
Reversal (Type Two) – A subtle trading strategy looks at the importance of large traders in determining where the market will go next. When large traders start to reverse their positions (i.e. the large investors line’s trend starts reversing), we can expect a market reversal most of the times.
Finally, what can we expect from this indicator? While it’s very useful to spot trends reversals, the COT report does not provide a holy grail to trading. First, this information is more relevant for long-term trades; second, it needs to be complemented by other information and knowledge of other forces that move the market.
If you want to further understand how to correctly identify these forces and to correctly understand market sentiment keep following our comments in the blog, or look at our indicators and take advantage of successful trading strategies.