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The Commitments of Traders Report
by Murray Ruggiero

Cybernetic Trading Have you ever wished you knew what position great traders like John Henry and Paul Tutor Jones currently had open? With this information, you would, in effect, have access to all of the research they paid millions of dollars for, and you would be able to piggyback their trades.

This information is available to you, a few days after the great traders have made their moves, in a report called the Commitments of Traders (COT) report, published by the US Commodity Futures Trading Commission (CFTC). The COT report tells how many contracts large professional traders are currently long or short.

What is the Commitments of Trader Report?

The Commitments of Traders (COT) is a weekly report released by the Commodity Futures Trading Commission (CFTC). The COT report outlines how different types of traders are positioned in the futures markets. There are two main types of traders in a COT report: commercials and money managers.

Commercial traders are hedgers who are trading a given commodity because they have a business that produces it or they need it as an ingredient or material in a product. For instance, Eastman Kodak, which depends on silver, may hedge against a rise in silver prices.

Generally, the data in the COT reports is from Tuesday and released Friday. The CFTC receives the data from the reporting firms on Wednesday morning and then corrects and verifies the data for release by Friday afternoon.

How Do Commercial Traders Work?

You may be skeptical about the value of this information, considering that it is 3 days old (and during earlier years of this data series, was even 2 weeks old). The information is still valuable because it tells how large commercial traders work. They manage their positions by using a process called accumulation and distribution. Because of the size of their positions, most commercial traders are countertrend traders. They buy as prices fall and then begin to sell into the rally. Because of this process, the COT data could lead the market by 2 weeks or more.

Using the COT Data to Develop Trading Systems

Let's now talk about how to analyze the COT data. The COT report supplies the number of contracts each group is long or short, as well as the number of traders in each group. It also publishes the number of spreads put on by each group, and the net change and percent of open interest each group holds.

The first step in using this data is to calculate the net long position for each group. This is done by subtracting the number of long contracts from the number of short contracts. When there are more longs than shorts, the number is positive. When there are more shorts than longs, the number is negative. The absolute levels of the net long commercials are not important. What is important I how these levels compare to the historical normals; for example, in markets like silver, the commercials have never been net long.

The COT data are predictive because the large traders have a lot of money and their inside connections give them an edge over the public. If you were to use the positions of the small traders, the results would be the opposite, because these traders are normally wrong.

Steve Briese's newsletter, Bullish Review, uses an index based on COT data to give trading recommendations. This index is an oscillator based on the net long positions for a given trading group. We calculate this oscillator as follows:

COT Index = 100 x (Current Net – Lowest (Net, N))/(Highest (Net, N) – Lowest (Net, N))

N is the LookBack and can vary between 1.5 and 4 years.

This indicator is scaled between 0 and 100. When calculating this indicator using the commercials, 0 is the most bearish and 100 is the most bullish. We generate a buy signal when this index is above 90, and a sell signal when it is below 10.

When we calculate this indicator using small traders' data, the lower values are more bullish and higher values are more bearish. Compared to the indicator calculated using commercials, this is an opposite result because small traders often buy tops and sell bottoms.

The COT report is a valuable indicator in many markets – T-Bonds, the S&P500, the agricultural markets such as corn and soybeans, and markets such as gold and crude oil. On the other hand, the COT report does not do well in markets such as currencies because, in these markets, futures represent only a small percentage of the complete market.

How can the COT report be used to develop mechanical trading systems?

We tested the classic rules for the COT index in several markets and found that they produced unimpressive results. This is not to say that the COT data are not predictive. Combining the COT index calculations, using both commercials and small traders, produces some very impressive results, and we developed a basic model for using the COT weekly data in this way. The rules are:

  1. If (COT Index Commercials)[Lag1] > Ctrigger and (COT Index Small) < Strigger, then buy at open.

  2. If (COT Index Commercials) [Lag1] < Ctrigger and (COT Index Small) > Strigger, then buy at open.

Ctrigger is the level of the trigger used to generate buy or sell signals based on the commercials' version of the COT index. Strigger is the level for generating buy and sell signals using the small traders' version of the COT index. The higher the index is when calculated using the commercials and the lower it is when using the small traders, the more bullish it is. The lower the index is when calculated using the commercials and the higher it is when using the small traders, the more bearish these data are for that market. Lag1 is the delay in weeks for the values used in our model. Because the COT index calculated using commercials leads the market at turning points, the COT data are more predictive if we lag the index calculated using commercial traders.

 
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