The primary way that I use the COT report, for my currency trading, is to concentrate purely on the non-commercial group of traders, and ignore the rest – why? – the simple answer is this – if you understand futures trading you will know that the market is split primarily between two groups – speculators and hedgers , which is broadly the classification we have here, except in the COT report they are called Non Commercial ( speculators ) and Commercial ( hedgers). The hedgers in general are the producers, growers, processors and distributors who are involved in the physical manufacture, production or processing of the commodity. The third group, ( non-reportables ) we ignore for the sentiment indicator. Now with currency, clearly nothing is being grown or extracted, but we still have the same groups. We still ignore the commercials, who in this case will be large companies hedging their forward purchasing of future deliveries and supplies. Now, one final point with regard to comparing currency pairs in the spot market, with currency contracts in the futures markets – they are reported differently, so please make sure, before you do any analysis, that when you look at a long contract, you are comparing this with a long contract in the spot market, and not a short one. This is easy to do as the futures contracts are all quoted using the US dollar. Let me give you an example – on the CME, they have recently introduced a live data system which compares the spot prices with the futures prices in real time. When you look at a pair such as the USD/JPY, you will see two prices quoted, the ‘conventional’ spot price and the ‘inverted’ futures price as shown below :
- Spot market quote : USD/JPY – 1.15
- Futures market quote ( CME ) : – JPY/USD – 8695
In the futures market quote, the decimal point is normally dropped, but in essence it is 1/1.15 = 0.8695. Now if we are looking at long JPY/USD futures then we are buying yen and selling US dollars, the opposite position of a long contract in the spot market where a long contract would be buying US dollars and selling yen – so we always need to careful when comparing futures and spot contracts – you have been warned!!
So the first way I use the COT report is to use it as a sentiment indicator for the longer term, and I do this very simply as follows
- Just look at the futures contacts for Non Commercial
- Ignore the spreads
- Subtract the long from the short to give the net long, or short position overall
- Plot this on my weekly chart
- When the net sentiment is above or below the line more than 4 weeks running, then I consider that the sentiment has changed.
I have included a copy of my chart for you below, so that you get the idea ( which is very simple ) – this is for the last four months of 2007 and the first month of 2008 up to 22nd January.
As you can see the blue is long futures, the yellow is short, and the purple is the net position, which has been positive but falling since September 2007. Now remember we are looking at the reverse position here, so in the cash market the long futures are short USD/CAD and short futures are long. The net position is now approaching zero and may well cross over into negative territory when the balance moves below the line to become net short. Once this has happened for four consecutive weeks then I will be looking to go long in the spot market, having first compared this with the technical position on my charts.