COT Report
Market Sentiment
Market Sentiment Indicator: Commitment of Traders (COT) Report
Commitment of Traders (COT) Report is a useful tool for gauging market sentiment. This post will cover:
What is the COT Report? COT reports break down the positions of various market participants, with the Traders in Financial Futures (TFF) Reports offering more detailed categorizations compared to the Legacy Reports.
How to Find TFF Reports? The TFF data can be accessed through the Commodity Futures Trading Commission website or third-party websites which provide user-friendly visualizations.
How to Use TFF Reports for Trading? When trading, investors can use TFF reports to identify trends with the positions of large speculators, spot reversals with hedgers (market makers), and monitor changes in open interest. However, like any indicators, the report should be used along with other analytical methods for a well-rounded market perspective.
What is Market Sentiment?
Market sentiment is the general attitude or mood of investors toward a particular asset or the overall financial market. It encompasses the collective views, ideas, and opinions of all market participants. The dominating emotion often drives the direction of the market. When market sentiment is positive (bullish), prices tend to rise. Conversely, when sentiment is negative (bearish), prices tend to fall.
How to Gauge Market Sentiment?
To maximize returns, investors need to assess the prevailing market mood correctly and act on it swiftly. One common method is to analyze trading volume. For example, if a stock price has been rising but its volume is declining, it may signal that the stock is overbought and could soon reverse. On the other hand, if a stock that’s been falling suddenly rallies on high volume, it might suggest that the market sentiment has changed from bearish to bullish.
In markets like CFDs and forex, which are traded over-the-counter without a centralized exchange, measuring sentiment through volume is more challenging. However, Commitment of Traders reports could provide valuable insights on market sentiment by tracking participants’ positions in the futures markets.
Gauging Market Sentiment with COT Report
What is COT?
The Commitments of Traders (COT) is a weekly report published by the Commodity Futures Trading Commission (CFTC). Released every Friday at 3:30 p.m. Eastern time, the report covers trading data from Tuesday of the previous week to Tuesday of the current week.
The COT report provides details on how participants in the U.S. futures markets are positioning themselves. It reveals their commitment in terms of positions held in futures contracts.
COT Report Types
Among investors, legacy reports and traders in financial futures reports are most relevant and important.
1. Legacy Reports
Legacy Reports are broken down by exchange, with Chicago Mercantile Exchange (CME) report being most viewed due to CME’s prominence as one of the largest and most influential futures exchanges globally. The CME hosts a wide variety of futures contracts, including those for major commodities, currencies, interest rates, and stock indices, attracting a diverse range of market participants, from hedgers to large speculators. As a result, the COT data for the CME is highly valuable in tracking how different groups are positioned in the market.
Legacy reports break down the reportable positions into two categories: commercial and non-commercial traders.
Commercial Traders (Hedgers)
Commercial traders are big institutions who use futures markets primarily for hedging purposes, aiming to protect themselves against the unfavorable price movements. Their goal is to reduce risk rather than seek profit. Let’s explain with an example.
Suppose you own a big car company in the United States that imports parts from Japan, requiring payment in Japanese yen. If the USD/JPY exchange rate drops, you will need to spend more U.S. dollars to purchase the same amount of yen, leading to potential loss.
To hedge against this risk, you can buy JPY futures, expecting that Japanese Yen will appreciate against the U.S. dollar.If the USD/JPY exchange rate falls, profits from your JPY futures offset your losses from currency conversion Conversely, if the exchange rate rises, losses from your JPY futures is also offset by your gain from exchanging dollars at a favorable rate.
Therefore, commercial traders use futures markets to hedge against currency fluctuations rather than profit from price trends.
Non-commercial Traders (Large Speculators)
Non-commercial traders are large speculators such as hedge funds, trading advisors, and other major financial institutions. Unlike commercial traders, they are primarily focused on making profits and tend to follow market trends. Non-commercial traders tend to buy in an uptrend and sell in a downtrend, seeking to capitalize on market movements.
Since non-commercial traders engage in speculative trading and are sensitive to or can influence the market trend, it can be advantageous for retail investors to monitor their behavior.
2. Traders in Financial Futures (TFF) Reports
Traders in Financial Futures reports include financial contracts, such as currencies, US Treasury securities, stocks, and more, offering a more detailed breakdown of reportable positions than the Legacy Report. It includes four categories:
Dealer/Intermediary
Dealers or Intermediaries are typically large financial institutions, such as banks or broker-dealers, that make markets in futures contracts. Their main function is to provide liquidity to the market by acting as intermediaries between buyers and sellers. They often hold positions to manage risk associated with their dealings in other financial instruments.
Asset Manager/Institutional
This category includes institutional investors, including pension funds, endowments, insurance companies, mutual funds and those portfolio/investment managers whose clients are predominantly institutional. They hold positions in financial futures to manage long-term portfolio and investment.
Asset Managers' positions in the TFF report are often closely aligned with market sentiment, especially over the longer term. This is because asset managers, such as pension funds, mutual funds, and institutional investors, tend to take positions based on fundamental analysis and long-term views of the market. Since they are less speculative and more focused on portfolio management, their positions reflect real economic outlooks.
In the case of the USD index from 2021-2024, the asset managers’ positions generally align with the fluctuations in the USD index.
Therefore, if you trade with a long-term strategy, it’s advisable to monitor asset managers' positions.
Leveraged Funds
Leveraged funds, typically hedge funds and various types of money managers, use leverage to enhance returns. They actively trade futures contracts based on market trends.
Since leveraged funds engage in more speculative trading rather than hedging, they are sensitive to short-term fluctuations. In the chart below, the positions of leveraged funds approximately align with the price movements of the USD index from January to August 2024.
However, from a long term perspective, the positions by leveraged funds appear much more volatile than the price movements, as shown in the below chart which presents price movements and positions from 2021 to 2024.
Therefore, if you trade in a short-term strategy, the positions by leveraged funds can serve as a good reference.
Other Reportables
This category includes all other traders who don’t fit into the first three categories but hold positions large enough to be reported. This could include smaller institutions, family offices, or other financial entities.
Difference Between Legacy and TFF Reports
In general, the legacy report offers a basic overview of hedgers and speculators, while the TFF report offers a more granular perspective by categorizing different financial traders, especially by distinguishing Asset Managers (long-term speculators) from Leveraged Funds (short-term speculators). Given that TFF reports are more nuanced and informative for small speculators like us, we’ll focus on TFF in the following sections.
Both reports include non-reportable traders, who are small traders whose positions are not large enough to meet the CFTC’s reporting thresholds. Their positions are aggregated instead of breaking down in the report. When reviewing the COT reports, we generally overlook this category.
Terms on TFF Report
To effectively interpret the TFF report, it’s essential to understand the following terms:
1. Long: The number of long contracts recorded by the CFTC (contracts bought).
2. Short: The number of short contracts recorded by the CFTC (contracts sold).
3. Open Interest: Open interest in the COT report is calculated by adding all the contracts from opened trades and subtracting the contracts when a trade is closed.
Here’s how it works in practice:
If Alice and Ben are trading the same futures contract:
If Alice buys six contracts to enter a long trade, open interest increases by six.
If Ben decides to short the market and sells four contracts, open interest increases to ten.
Open interest remains at ten until the traders exit their positions. When Ben closes his position by buying back his four contracts, open interest decreases to six. Until Alice decides to sell her six contracts, open interest will remain constant at six.
You can think of open interest as the cash flowing into and out of the market. As open interest increases, more money is moving into the futures contract; as it declines, money is exiting the futures contract. Analysts typically use open interest to confirm the strength of a trend. Increasing open interest confirms the trend, while decreasing open interest may signal that the trend is losing strength.
How to Find the TFF Report?
A. Search on the CFTC Website
Visit the CFTC Website:
Go to the official CFTC website: https://www.cftc.gov.
Navigate to the COT Reports Section:
On the CFTC homepage, hover over “Market Data & Economic Analysis” in the main menu.
From the dropdown, click on “Commitments of Traders”. This will take you to the page where the COT reports are hosted.
Select the Current Traders in Financial Futures Reports:
On the COT page, you’ll see various report types. Look for the "Current Traders in Financial Futures Reports" section.
Look for the “ Financials” row and check the next column within the same row to find “Long Format” under the “Futures Only” column heading.
Click on this “Long Format” to access TFF data.
Search Futures Data That Interests You:
Use “Ctrl + F” to search specific futures data. For example, if you are interested in the British Pound, simply search (Ctrl + F) for “POUND”.
B. Search on Third-Party Website
Several websites provide user-friendly interfaces and visualizations for the COT reports, one of them is Tradingster.
Tradingster summarizes and visualizes the essence of COT data by offering a chart of net positions of each category. Net position is arrived at by subtracting the short positions from the long positions. If a category holds more long positions than short positions, i.e., the net position is positive, this category is bullish. Conversely, if the net position is negative, the category is bearish.
Here is an example of calculating the net position as of September 17, 2024:
Net Dealer Position = Dealer Long - Dealer Short = 7,567 - 89,712 = - 82,145
Net Asset Manager Position = Asset Manager Long - Asset Manager Short = 56,250 - 26,258 = 29,992
Net Leveraged Funds Position = Leveraged Funds Long - Leveraged Funds Short = 30,066 - 45,846 = -15,780
In the following sections, any references to COT data will pertain specifically to these COT net positions.
How to Use TFF Reports for Trading?
1. Identify Trends with Asset Managers and Leveraged Funds
Asset managers and leveraged funds, often referred to as large speculators, typically aim to profit from price movements. As a result, they tend to follow market trends closely. When analyzing TFF reports, an increasing number of long positions (buying) in an asset by these larger speculators can serve as a strong indication that bullish sentiment is prevailing. Specifically, those large speculators continue to bet for the continuation of the uptrend when they keep building up long positions as the price goes up.
In the case of the JPY/USD pair below, while the price of this pair has risen since November 2022, the asset managers began reducing short positions and built up more long positions in February 2023. The alignment between the uptrend in JPY/USD and the increase of long positions by large speculators indicates that the price movement is supported by substantial market activity.
Conversely, if a price trend occurs without a significant increase in large speculators, it may signal a potential point of exhaustion. For instance, in the chart below, it’s obvious that the uptrend in EUR/USD early December 2023 lacked significant commitment from large speculators, signaling the uptrend was running the risk of exhausting. As a result, the price of this pair fell in early 2024.
2. Spot Reversals with Dealers
Like the commercial traders in legacy reports, dealers also fulfill a function of net hedgers, so it’s not at the core of their business model to speculate in future price movement.
The behavior of dealers can sometimes be a contrarian indicator. Since these participants are hedging against price movements, a notable increase in their long positions may suggest that the price of an asset has fallen too low and could be approaching a bottom. This could indicate a potential reversal in the downtrend, signaling a buying opportunity for traders who believe that prices will rebound. Similarly, if commercial traders are significantly increasing their short positions, it could mean they believe the asset is overvalued and due for a correction. This often occurs when prices have risen substantially, and commercial traders expect a pullback.
For example, in the case of JPY from November to December 2022, as the JPY/USD exchange rate climbed, dealers increased their short positions to hedge against potential downside. From mid-January to mid-February 2023, these net short positions reached a historical high, suggesting the market could be nearing a reversal.
Monitoring the behavior of dealers offers valuable insights into potential market turning points, especially when their positions diverge significantly from those of asset managers and leveraged funds.
3. Monitor Changes in Open Interest
Open interest refers to the total number of outstanding contracts in a futures market and is a critical measure of market activity. A rising open interest, particularly alongside an upward price trend, suggests that new capital is flowing into the market, strengthening the current trend. This is a key signal that the momentum behind the price movement is robust and likely to continue, as more participants enter the market with strong convictions.
However, if open interest decreases while prices continue to rise, it could be a sign that the trend is losing strength. This often happens when traders start closing their positions, indicating that fewer participants are willing to support the ongoing price movement. Such a divergence between open interest and price could be an early signal of a market top, where a reversal might be imminent. Similarly, in a declining market, decreasing open interest while prices fall can suggest a weakening downtrend, signaling a potential bottoming out.
By closely monitoring changes in open interest in conjunction with price movements, traders can better gauge the sustainability of a trend and anticipate possible reversals. This can be particularly valuable in volatile markets where sentiment can shift quickly, allowing for more informed decision-making.
Disagreement Between Price and COT Positions
While COT data can provide valuable insights into market sentiment, it is important for investors to understand that this data should not be used in isolation. COT reports reflect the positions of various market participants, but these positions do not always align perfectly with price trends. In some cases, there may be a divergence between the positions reflected in the COT data and actual price movements, which can lead to misleading conclusions if investors rely solely on this information. For instance, in the chart below for EUR/USD, euros begin a downtrend (in yellow) but the asset managers build on more long positions (in red). The divergence occurs.
One reason for this divergence is that COT data represents historical positions, typically published with a lag. This delay means that by the time the data is available to the public, market conditions may have already changed. For instance, a large net long or short position could signal a potential price movement, but the actual market may have already reacted to the underlying forces by the time investors see the report. As a result, relying exclusively on COT data without considering real-time price action and other market indicators can lead to missed opportunities or incorrect assumptions about future trends.
Additionally, the motivations behind the positions reported in the COT data can vary significantly across different types of traders. Commercial traders, for example, often hedge their positions to protect against adverse price movements, rather than to profit from directional trends. This can sometimes create a false impression of market sentiment, as large hedging activities may be interpreted as speculative bets, when in reality they are risk management strategies. Therefore, it's crucial for investors to analyze COT data within a broader context, considering technical analysis, fundamental factors, and current market conditions before making decisions.
To wrap, while COT data offers valuable insights into market dynamics, it should be viewed as one piece of the puzzle. Investors should avoid over-relying on this data and instead combine it with other analytical methods to form a well-rounded view of the market. This approach can help minimize the risks of acting on outdated or incomplete information and enable more informed decision-making in dynamic market environments.
Conclusion
In summary, the Commitment of Traders (COT) report is a useful tool for understanding market sentiment and positioning in the futures markets. By analyzing the behavior of different trader categories, investors can gain insights into potential market trends and reversals. Utilizing metrics such as open interest and monitoring the activities of major speculators can enhance trading strategies and decision-making. However, it’s essential to integrate COT data with other analytical methods and real-time market conditions to develop a comprehensive view and mitigate risks in a dynamic trading environment.
