UNDERSTANDING COT REPORTS IN FOREX
Forex market runs on the basis of market players’ optimism or pessimism reflected on any currency pair at a given point in time. This is a collective emotion, which is technically called market sentiment. It is this collective sentiment that determines whether the market should behave in a bullish or bearish pattern.
While individual traders prefer to move in the same direction of the market sentiment, large commercial players often prefer to move in the exact opposite direction of the market sentiment.
To ascertain this, players depend on a number of tools called sentiment indicators that show near-perfect picture of market sentiments. Some of such sentiment indicators include:
- CBOE Volatility Index
- Put-Call Ratios
- Odd-Lot Trading Statistics
- Mutual Funds Statistics
- New York Stock Exchange High/Low Indicator, etc.
COT Report – The Ultimate Sentiment Indicator
The most commonly used and most valuable sentiment indicator is the Commitment of Traders Report (COT). Issued by the Commodity Futures Trading Commission every Friday, COT report shows the average position of group of traders in the futures market of previous Tuesday. This is prepared based on the weekly data submitted to the Commodity Futures Trading Commission by the market participants themselves listing their position.
This report clearly shows the position held by 3 different types of traders:
- Hedgers - Mostly, these are large MNCs with commercial hedging interests.
- Large Speculators - These include large institutions like Commodity Trading Advisors, who speculate in specific futures market.
- Small Speculators - These include leveraged players without a deep wallet.
Why use COT report?
As the COT reports are linked to the futures market, it can be used for Forex trading on those currency pairs that do have futures contract. Thus, EUR/USD, AUD/USD, GBP/USD, and the like can be traded with the help of COT reports.
The major goal for using COT report is to understand the trend to make it your friend.
COT reports help provide increased transparency on operations in the futures market. This helps to simplify the complexity of exchanges that happen in the futures market.
Being a weekly report, COT provides traders with up-to-date information on the happenings in the futures market. This makes it a lot easier and less risky for forex traders to arrive at right decisions and execute their trades. Not just for the traders, but even for researchers, COT report has much to offer. Most academic researchers make use of COT reports in their researches.
How to use COT report?
COT reports are best used as long-term trading tools. There are several methods to make good use of COT reports. Some of them are as follows:
- Using COT as Reversal Indicator: One method is to use it to find extreme positions – such as extreme short position or extreme long position. This is because these extreme positions indicate that a trend reversal is just around the corner, and so smart traders can take their trades accordingly.
- Using COT as Trend Finder: COT report shows the collective sentiment of the players – whether they are thinking optimistically or pessimistically. This gives a clear idea about how the trend is moving. Hence, one of the very basic rules of any market is to befriend the trend, which can be done using the COT report in this manner.
- Using COT as Volume Indicator: As COT reports are issued every week, it can be used as a powerful volume indicator. To do this, you need to closely watch the open interest numbers of an asset. An increased open interest number simply indicates that more people are trading the futures contract of that particular asset.
- Using COT to Create Portfolio: The COT report can give valuable insights into creating a diversified currency portfolio. You can create a portfolio that is interest-neutral or one that is more volatile or one that is highly risky based on your temperament in trading.
The Bottom Line
COT report has over the years evolved into a handy tool for all kinds of traders. Traders are finding reliable methods of making use of this valuable tool. However, it is always safer to confirm these signals with data from other fundamental and technical analysis before arriving at a trading decision.