How to analyse Commitment of Traders

Calculating Net Position of traders

In Commitments of Traders (COT) report, long and short position of each trader category are shown. It is useful to look at “net” position of each trader to gauge the overall trend of position movement of each trader.

Net position is defined as follows:

Net position = long position – short position

Here is Australian dollar sample chart with net commercial position, net non-commercial position, net retail position.

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As you can see from above chart, commercial and non-commercial take opposite position. It is almost mirror image. This is the same for most of futures products. When one trader takes long position, there is always another counter-party who takes short position. When commercial as a whole takes net long position, non-commercial as a whole takes net short position, and vice-versa.

Net Commercial and price movement

As Larry Williams mentioned in his book, the position that commercial traders are taking is important indicators of price movement especially for commodities. Commercial traders are the companies which actually engage in business activities in the respective industry. They are the ones who know the supply and demand of the products the best. Generally speaking, when commercial traders are accumulating extremely high net long positions, that is bullish sign.

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If you look at the above Wheat chart, extreme high net commercial positions have been followed by price up-trend, and extreme low net commercial positions have been followed by price down-trend.

However, we should be careful about commercial traders’ position. Their object is to hedge their exposure to price volatility. When price volatility increase, they might increase futures positions regardless of price direction. We think positions of non-commercial such as hedge fund gives more valuable information in general.

Net Non-Commercial and price movement

Non-commercial such as hedge fund are speculators who are trying to exploit profits from price volatility. They have access to information which retail investors do not have access to and hire highly educated professionals to analyze market supply and demand. Even though Larry Williams wrote in his books that these non-commercial traders tend to be wrong, we think it is worth looking at positions they are taking.

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Above chart shows weekly Euro price chart with net non-commercial positions. As you can see in the chart, net long positions of non-commercial traders aligned with price up-trend, and net short positions of non-commercial traders aligned with price down-trend.

 

Net Non-retail and price movement

Retail investors are the ones with least knowledge of the industry. It is said that 99% of retail investors lose money in the markets. It is better not to follow retail investors. Larry Williams mentioned that when retail investors are accumulating long positions, it is time to go short, and vice versa.

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Above chart is crude oil weekly chart with net retail position. As you can see from chart, extreme high net positions by retail investors were followed by price down trend.