Commodity traders are able to look into a special report released by the the Commodity Futures Trading Commission (CFTC) every Friday at 3:30 p.m. EST. This is called the Commitment of Traders report, also known as the COT report. It provides an overview of the positions held by both institutional traders and small speculators, across a broad range of futures markets.
This report is considered useful for forex traders too. In this weekly report, the CFTC segregates the total long and short positions held by participants into three trading groups. Knowing these positions can be useful for determining the overall market sentiment. A forex trader can then form long term trading strategies based on that.
The COT report shows data for both futures and options positions held by commercial, non-commercial and non-reportable traders.
Here are some terms you should be familiar with to decipher the report:
You might wonder why activities in the futures market would be relevant for FX trading. The reason is that a large percentage of the spot FX market is traded over-the-counter (OTC), and transactions are not recorded on a centralised exchange, like the Chicago Mercantile Exchange (CME).
The forex market doesn’t have a volume indicator, as a result. By tracking the currency and commodity futures allocations by large institutions and smaller speculators, traders can use the COT report as a volume indicator.
Some of the biggest global companies, who have access to real-time economic data, come to the futures markets to hedge their exposure to raw material price fluctuations. Forex traders can find this data useful in gauging the positioning of the market at a certain time.
Also, the report is useful for determining long term strategies, due to its lagging nature. It gives updates regarding the previous weeks’ positions, rather than just for a few days.
Understanding the different players in the report can offer clues about price movements. For instance, non-commercial traders are usually price speculators and trade in the direction of the anticipated price movement. Commercial traders are usually in the market to lock in gains for clients rather than hedge risks, and they tend to place trades in a direction opposite to the expected price direction.
The non-reportable traders are contrarian traders, taking positions against both these categories. Understanding the net position can help judge market sentiment. Many traders concentrate on the non-commercial trader category, since they find their own interests aligned with these traders.
If the net position is negative, speculators and commercial traders are “net short.” There are more short contracts than long ones, which indicates an overall bearish sentiment. When the net position is positive, traders are “net long.” Here, the number of long contracts exceeds that of short ones, which means that the market has a bullish outlook.
Open interest is vital information to look into. This represents the total number of contracts that have been entered into, but not yet executed. Futures contracts are derivative instruments, where two parties agree to make a transaction in the future, on a price decided upon today. When a contract like this is established, the open interest figure increases by a value of “1.”
However, open interest parametres have no relationship with price movements. For instance, a decrease in open interest does not indicate decreasing price levels. At the same time, it is important to check the changing value of the open interest. Contract owners can change. This means that contracts often get passed on to different parties, and when this happens, the open interest figure does not change. So, just because the open interest remains constant, it does not mean that the market outlook has not changed at all.
For instance, many long contracts held by small speculators can be acquired by commercial traders. So, speculators who initially expected the price to rise, have now changed their outlook and have sold their contracts to commercial buyers, who will trade against falling prices. Open interest didn’t change, but the market outlook did.
Open interest can also help track money flow in the market. If it is increasing for particular currency futures, it means that money is flowing into that asset. Moreover, an elevated interest is pushing the price higher, indicating a bullish trend. Similarly, if the price is decreasing, but the open interest levels rise, it indicates an overall bearish outlook or an upcoming downtrend.
Traders can also track the harmony in the positioning of commercial traders and speculators to confirm a trend. Both these classes of traders usually trade in opposite directions. This means that long commercial traders and short speculators should place trades in unison. Similarly, long speculators and short commercial traders need to place trades in unison. When they place trades in unison, the probability of the price moving with them becomes higher.
COT data is also used to determine whether interest is higher in risk currencies. Many forex traders use the data to pair strong currencies with weaker ones, to trade market reversals during mid-term trends. Technical indicator signals can be confirmed using the data, to see whether a majority of the traders think the same way you do.
The COT data is an important and versatile tool for forex trading. However, it is useful to use other fundamental analysis data to measure the validity of market volume.