The Commitment-of-Traders (COT) reports can sometimes give traders a good idea of future significant moves in the market. The CFTC requires large speculators and commercial traders, or hedgers, to report their net positions twice each month. In general, the large speculator category represents fund traders and professional traders who carry large positions. Commercial traders also report their net positions to the CFTC. The number “non-reportable” positions is derived from subtracting the number of large spec and commercial positions from the total open interest. This group of traders is generally thought to be small speculators and hedgers who are not holding a position large enough to report to the CFTC.
The COT report’s results can be used as a tool to give traders a better understanding of the psychology of the marketplace, the net position of the commercials in the market and the net position of the large traders. Large traders (funds) are typically trend-followers and will add or liquidate their positions depending on the technical action of the market since the release date of the report. There are many different ways to analyze the reports, but we believe that for the most part the large traders’ net position and “change in position” over a two week period are the most important numbers to watch. Keep in mind that the small trader’s net position is usually vulnerable to either long liquidation or short-covering if the market starts to move against them.
As a result, a classic bullish set-up for a given market would be when large traders are net long and small traders are net short. The market will be in a weakened bullish set-up “if” the two-week trend in the large trader position is down, or in other words, if the funds are in the process of liquidating their net long position. This is a warning flag. The larger the net short position of the small trader (relative to history) and the extent that small traders are holding a position “against” the trend are factors which will add to the bullishness of the report.
A classic bearish set-up in the market exists if large traders are holding a net short position (more bearish if adding to the position in the past two weeks) with small traders net long the market (more bearish if net long position is relatively large and the trend is decisively down). One exception we have noted recently is the ability of the small trader in T-bonds to hit the correct direction of the market. It is also important that the COT report with futures and options (released one day later) confirm the situation that is indicated by the futures only report.