The COT Report and How to Trade It in Forex

COT (Commitment of Traders) is a weekly report that provides a summary of how future markets players in the US have traded. The study comprises all of the major market factors’ positions in the United States, as well as their respective market shares.

This report is presented by the Commodity Futures Trading Commission (CFTC) every Friday. The COT report, as the name implies, makes traders’ commitments public.

A COT report won’t tell you the holdings held by a specific institutional trader. Rather, it just reports on various future contracts to a cumulative of all the participants. Furthermore, these market players are separated into three:

• Commercial Traders; large institutions that participate in futures trading as a means to protect themselves against the danger of negative price swings affecting their investments. Their motivation for trading is risk mitigation, not profit-making.
• Non-commercial: these are high market cap firms that are in the futures market to add to their already large capital base
• Non-reporting traders: this is a pool of investors whose trading positions are below the reporting threshold set by the CFTC. Because they are not disclosing, we have no way of knowing how many they are. The majority of market specialists believe that a significant portion of the market consists of individual speculators. They are well-known for being poor traders, and you will find them more frequently than not betting against the market trend.

COT trading strategies

It is extremely straightforward to develop your own technique based on this information or to use it to define your own biases based on it. Two examples of how this information could be applied are provided below:

1. For instance, you buy the currency pair each time the red sentiment line crosses the center of the chart and reverse and short the pair when the sentiment line crosses the middle point or neutral level.

Below is the daily chart of the Canadian dollar, with the COT reports chart in the indicator window.

2. In addition to the sentiment line, the net long/short line is essential to correct the reading of the trend. Short-term traders can utilize the sentiment line to determine which opportunities they are searching for by simply using the red line.

COT as a long term volume indicator

An extremely beneficial and wise usage of the COT report supplements the price studies given by standard technical analysis. In the event that a technical signal is not supported by a similar movement as indicated by increased open interest in the COT report, the trader might simply refuse to act on the signal. 

He would anticipate a commensurate increase in open interest in the case of an upswing and a considerable reduction in open interest in the case of a downtrend. 

When looking at stock market charts, this strategy is similar to combining both volume and price data at the same time. Those with minimal knowledge of other markets, however, can still gain substantially from its use, especially when it comes to purely technical trading.

Create a rich portfolio of currencies

It is possible to construct a diversified currency portfolio using the information contained in the COT reports. By analyzing the COT report, we can have a clear understanding of the position of large traders with regard to the USD, but we must establish a currency pair portfolio, to make effective use of these figures.

Because the market can be long the USD overall but short the USD against other currencies, we will want to stay away from pairs where the USD is likely to lose value even as the COT remains positive.  

In our hypothetical scenario, let us presume that the USD is long on the non-commercial sector. What are the parameters to determine the currency pairs that will form part of our portfolio in this situation?

Generally, our portfolio should not be outwardly showing our currency biases. Instead, we should be expressing our USD-positive outlook in our currency allocations while keeping our shorting currencies quiet.

We may, for example, choose to go short on AUDUSD and EURUSD and at the same time adopt a long position on USDJPY. We then have to balance our portfolio in such a way that ensures that the total interest rate paid does not surpass the FED rate. By taking this approach, we will profit from the gains of the USD while covering the downside of carry trade.

By making our stance interest-neutral, we hope that we can cope with these disturbances. This reduces the volatility of our portfolio as well as the potential profit margins, but it creates a more long-term, and comparatively more stable position.

In summary

Never depend, as we often stress, on any instrument or indicator to decide on your business. Instead, allow your trading tools to provide you with a trading signal to act on.

The COT report can be used to trade forex in the same way. Use it together with other tools, not as a substitute. Employ it in concert with your technical analytical tools to increase your chances of profiting and reduce your exposure to risk.