How to Interpret the Commitment of Traders (COT) Report

The origination of this report is the Commodity Futures Trading Commission (CFTC), a government regulatory agency that regulates the futures industry. Since 1962, the Commitment of Traders report (COT) has been available for review. The frequency of release dates has changed considerably to make the reports timely. From once a month to every two weeks and now weekly, we have access to this information. You can receive a weekly e-mail reminding you that the report has been released and then retrieve the information for no charge. Below is the link to subscribe.

https://service.govdelivery.com/service/subscribe.html?code=USCFTC_25

Every Friday at 3:30 pm EST the report is released. The results of this report show each Tuesday's breakdown of open interest in the futures markets in which 20 or more traders hold positions above the reporting levels established by the CFTC. Open interest is the total number of contracts that have not yet been closed out. Reporting levels are a way for the CFTC to track traders and help prevent any form of market manipulation by owning an excessive amount of contracts. Once a trader starts trading beyond these reporting levels, they are required to report to the CFTC on a weekly basis showing how many contracts they currently are long or short.

Figure 1 below will show you a recent corn COT report, and we will break down the major parts of the report and explain what they mean.

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Open interest is the total of all futures contracts entered into and not yet offset by a transaction or taking or making a delivery of the commodity itself.

Reportable positions are reported daily by futures clearing merchants (FCMs). An FCM is where all traders' capital is held in segregated accounts, and at the end of each day, their accounts are debited or credited by these firms. These FCMs know at the end of each day when all accounts are marked to the market and if any trader has exceeded the mandatory reporting level. When a trader is shown to be at these levels, his positions are immediately reported to the CFTC as a reportable position.

There are different classifications of these positions:

• Commercial and Non-Commercial Positions

• Non-Reportable Positions

Once a trader is reported to the CFTC, he is first identified as a commercial or non-commercial trader. If they use the particular commodity in the line of doing business (farmers, manufactures, etc.), they can be classified as commercial traders. This allows them to offset the risk of price volatility by hedging their products. Exchanges will also offer these commercials reduced margin rates because they are credit worthy and less risk to the exchange than an outright speculator would be. The CFTC will monitor these commercials' trading styles, and if they feel that the commercial is speculating more than hedging, they could lose their commercial status with the exchanges.

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The style of trading you find commercial traders doing mostly is buying when markets are going down and selling when they are going up. However, they have the financial and fundamental knowledge needed to absorb a large portion of the market's supply and demand and actually create market tops and bottoms.

If the trader does not use the commodity markets to hedge, they are known as a speculator. Another name commonly used to describe this class is “large traders.” This group can consist of managed or pooled money by hedge funds, commodity trading advisors, commodity pool operators, and individual large traders.

Large traders are generally considered trend followers. These traders have so much money to put to work in the market that they have to find these trends and stay with it for as long as possible. With such size in the market, their positions don't allow them to enter and exit the market too quickly.

Non-reportable positions are calculated by subtracting the long and short reportable positions from the total open interest. This class of trader is also known as the “small trader.” Small traders are typically the uninformed and late-to-the-trade style of traders. Most of the time, you want to trade counter to what these folks are doing. Many are blindly following newsletters and cocktail party tips. That said, we must be careful because this classification can lump in some pretty big traders. For example, in the Treasury bond market, you must report to the CFTC if you trade more than 1,500 contracts. I would agree that this is some big trading at that point. But think of this scenario: What if a trader is trading 1,450 Treasury bond contracts? Would you still call them a small trader?

Spreads measure the extent each large trader holds equal long and short futures positions. An example would be if a large trader in corn held 3,100 long contracts and 1,800 short contracts, 1,300 contracts will appear in the long category (they are net long 1,300 contracts) and 1,800 will appear in the spread category (they are short and long 1,800 contracts).

Changes in Commitments from Previous Reports

Under each category, you can see the net changes from the previous week. This also shows the net change in the cumulative open interest from last week.

Percent of Open Interest

Each category shows what percentage it is of the overall total open interest.

Number of Traders

This is the number of traders reporting to the CFTC as commercial or large traders. While this report is helpful to see what the commercial and large traders are doing in the market, it only gives you a snapshot from last week. I find it much more informative to see what the trend has been over the past year. For this, I visit a Web site called www.nowandfutures.com.

Figure 2 shows us a look at the corn market's participants over the past year. It also shows the three categories of traders and their net positions over the past year.

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We can start to see that the small traders are almost at their largest net short position over the past year, while the commercials and large traders are both net long this market. Usually, the larger traders have deeper pockets and cause the smaller traders to cover their positions first. We will have to wait and see if this is the case for the corn market.

Another way to use this data is to view Figure 2 as an overbought/oversold chart. For example, if you look at the small traders' vertical bars, you notice that over the last 52 weeks, we are currently in the lower 15% or so of that 52-week range. An ideal setup would be to see the small traders at such an oversold level and at the same time notice that the commercials or large traders are in the upper part (overbought) of their range, maybe around 85% of their 52-week levels. This would show net buying by the strong hands in the market, while the weak hands were selling.

Eventually, the commercials will absorb all the selling and the small traders will be forced to cover their shorts by buying the market.

Trading using COT information can be very helpful to swing and position traders in the futures markets. If we align ourselves with the strong hands of the market, we can have more confidence with our decision to stay with our trade for a longer period of time.

We should not use this information as a timing tool, but as a decision support tool to show us what side of the market the big players are on. To enter our trades, we will still need to do our technical analysis and consider our risk for the trade.

Keep your profits long and your losses short!

By Don Dawson, instructor, Online Trading Academy