Refining the Commitment of Traders Report Analysis

A recent article I published for Barchart described the basics of the Disaggregated Commitments of Traders (COT) net positions report released each Friday by the Commodity Futures Trading Commission (CFTC). Due to the reporting period of Tuesday to Tuesday, the report has a 3-day lag when released on Friday. The lag is insignificant when the data is looked at from a longer-term view. The original COT report was referred to as the Legacy COT report and was started by the CFTC in 1962. 

Today, multiple trader classifications exist, and the Legacy report cannot offer the detailed transparency the CFTC is trying to accomplish. To achieve this transparency, the CFTC broke down the Legacy COT report in 2009 into more defined categories, and the results were the Disaggregated COT report for 22 futures markets. Financial futures markets were excluded, resulting in the Traders in Financial Futures (TFF) COT report.

Source: CFTC

The table above illustrates the Disaggregated COT report from the CFTC. Looking at the line "Percent of Open Interest Represented by Each Category of Trader" will describe which category of traders is the most significant (biggest impact on the market) down to the most negligible (least impact on the market). 

Reviewing the categories in order of size:

• Producer/Merchant/Processor/User (Commercial Entity)
• Swap Dealers (Commercial Entity)
• Managed Money (Non-Commercial Entity)
• Other Reportable (Non-Commercials)

Producer/Merchant/Processor/User

The commercial entities that produce/process/refine the raw commodities are now reported alone in this category. The Legacy COT report combined the Swap Dealers with these commercials. 

Producers/Processors/Refiners are incredibly knowledgeable in their area of expertise. They are known as the smart money in the futures market arena. 

Specialists like this know all the fundamental and seasonal information about their products. 

Their style of trading is scaling into positions. You will see them buying in downtrends and selling in uptrends. The large number of contracts they trade makes it impossible to enter at just one price. 

Swap Dealers

In simple terms, swaps are off-exchange non-standardized contracts that trade in the over-the-counter market. Here are a few differences between futures contracts and Swap contracts: 

• Swaps allow participants to get delivery from anywhere rather than a specific location that a futures contract would use.
• Delivery dates can be anytime, unlike a delivery from a futures contract can only occur at the end of the futures contract expiration.
• The quality of the product can be different than ordinarily written in a futures contract.
• The units for delivery can be of any size in a Swap contract, whereas in a futures contract, the unit size is standardized.

A Swap Dealer is an entity that deals primarily in Swaps for a commodity or financial instrument and uses the futures markets to manage or hedge the risk associated with those Swaps transactions. A Swap Dealer could be a large bank (Goldman Sachs, JP Morgan, etc.) or a hedge fund.

Managed Money

These are money managers seeking a return on investments for their clients. A money manager could be a Hedge Fund, Commodity Trading Advisor (CTA), or Commodity Pool Operator (CPO). 

For longer durations, managed money usually uses trend-following strategies. When we look at a COT chart, we notice that managed money and the current market trend are highly correlated. 

Other Reportable 

Traders reported by the CFTC as large traders but didn't qualify for the other three categories will be placed in Other Reportable. 

These can be individual traders who trade significant contract positions.

Charting the CFTC Raw Data 

The CFTC table above may have been overwhelming for you. Fortunately, this raw data is collected and cumulatively displayed on charts so we can interpret market prices' strengths and weaknesses. 

Barchart collects the CFTC COT report data and creates informational charts: 

Barchart has a charting feature called "Flip Charts," allowing users to scroll through numerous pre-configured markets to identify potential COT setups. 

Interpreting the Disaggregated COT Report 

The two largest categories in the futures market are the producer/processor traders and the managed money. You will see that their trading positions are always non-correlated. The majority of managed money managers use trend-following strategies. The line representing the money managers is highly correlated to the direction of the price action. The producers/processors will dollar cost average into their positions, and you will find them buying in downtrends and selling in uptrends. The line representing producer/processors is highly non-correlated to price action. 

Exchange rules limit the number of open positions speculators can have in any market. Viewing the direction of the managed money can help identify a longer-term trend. But, sometimes, trends can go too far, and they become weak trends because there are not enough buyers/sellers left to maintain the trend. 

Producers/processors, however, have no exchange rules restricting them to a finite number of open positions because they are hedging positions. 

Two things to view when scrolling through the Barchart flip charts: 

• Are managed money positions trending up/down?
• Have these trends come to an extreme?

If you notice that week after week, the COT report shows managed money is adding to their long or short trends, consider joining them using your entry and risk management skills.  

One way to analyze the data for the COT chart is to view one year of data. When the current managed money positions are the most bullish extreme of the past year, then this is a time the uptrend could reverse. When the current managed money positions are the most bearish extreme of the past year, then this is a time the downtrend could reverse. Traders need to be careful when timing the end of a trend because sometimes the trends can continue for more extended periods. 

After Scanning for COT Setups on Barchart…. 

Visiting the Chicago Mercantile Exchange Group (CMEGroup) website will allow us to delve deeper into the Disaggregated COT report. When scanning for COT setups on Barchart, you are looking at the net difference between the number of longs and shorts each category currently holds. 

The CMEGroup website will display the number of longs and shorts each category holds in a graphical form. 

Source: CMEGroup – CMEGroup Commitments of Traders Charts 

Clicking on the "Settings" tab, the only change needed is to change "Secondary Plot Value" to "Future Price." Clicking on the "History Range," select "1-year.' 

After changing these features and selecting the managed money category, your chart should look like this. The yellow line is the futures price, and the vertical bars are your gross positions per the key at the chart's top. 

Scrolling back up to the Barchart COT chart, you will notice that when corn made its July low, the producers/processors (red line) rose as the price went down. And the managed money (blue line) was declining as prices went down. Once the July low was put in, the managed money started buying, and the price trend turned up. 

The CMEGroup corn chart above shows the July low price (yellow line). When the price started increasing, the managed money category added to their long positions each week (the blue bars were getting higher). At the same time, the short positions (red bars) were reduced—a positive divergence between longs and shorts. The CMEGroup's chart confirms that the managed money-long positions were new buying. The Barchart COT graph showed the net positions getting more bullish, but we did not know if the rally was a short covering rally or new long positions being made. 

If the price rally off the July lows had been short covering, the gross long positions would not have increased each week; the short red lines would have decreased. 

Summary 

Combining Barchart's Disaggregated COT net position scan with the CMEGroups gross long and short positions is a way of confirming if a price rally/decline was new positions coming in the market or liquidation of existing positions. 

The COT report is not a timing tool. Traders must use other technical or fundamental analyses to enter and manage the trade. 

By combining seasonal patterns, COT reports, and technical analysis, traders can increase their chances of finding a market ready to trend up or down.