Finally, to round off this chapter I’m going to explain one of the more intricate pieces of relational data that we can use in analysing the currency markets. And this is the COT report, which stands for the Commitment of Traders report.
This report is issued each week by the CFTC, the Commodity Futures Trading Commission which is the financial regulatory body in the US, responsible for administering and regulating all trading in US markets.
Every Friday afternoon, the CFTC issues a report which provides a wealth of information about the futures markets, and in particular, the changes in trading volumes across a huge range of commodities, currencies and treasuries. Buried within this report is the information that we use as forex traders to give us yet another perspective, from a secondary piece of market information. However, there are two problems with this report.
First, it is extremely long, complicated and full of jargon, and it is not presented in an easily digestible format.
Second, it is based on data, up to and including the previous Tuesday, so by the time it is published it is always three days out of date. Nevertheless, it is another useful piece of the jigsaw and one which gives us an insight into the weight of money in the market, and where it is for each of the major currencies. Yet another view of market sentiment for each currency and, of course, another view which is based on volume.
The best way to use this data is to keep it very simple. But the data can be used in many different ways. The explanation here is based on my own interpretation.
Every Friday afternoon at 15.30 EST, the CFTC releases all the data covering the previous week’s trading in futures and options, in a series of consolidated reports from all the major exchanges covering the four capital markets.
The data is based on figures to the previous Tuesday which are then consolidated into the report released three days later on the Friday.
Until recently, the CFTC only produced this data in one format. However, in 2009 this all changed. A more detailed report was devised which reported the figures in a revised format.
In theory, the logic was to provide more transparency for everyone. Unfortunately the exact opposite appears to have happened resulting in the CFTC producing even more complex and jargon filled reports.
Fortunately for us, the CFTC does still produce the old report in its simple format, and this is the one I prefer to use. This version of the report gives me all the information I need in a quick and relatively easy way and this what I want to share with you here.
I’m going to show you where to find the information, what to look for, and then I’ll explain how to use the data in the reports.
The weekly data is issued on the CFTC site at http://www.cftc.org/ and on the home page we look for the market reports tab at the top of the page.
Fig 11.32 Market Reports
Hover over this tab, and a drop down menu will appear, and from this menu click on the first which is 'Commitments of Traders' which will then open the page shown in Fig 11.33:
Fig 11.33
Scroll down the page and ignore everything including ‘disaggregated reports’ and look for the following as shown in the image. The ‘disaggregated reports’ are the new style format, and very confusing in my opinion, so please ignore them. Instead what you are looking for are the current legacy reports which appear lower down this page and appear as shown in Fig 11.34.
Current legacy reports simply means the old style reports which are the ones we want. Next look for the CME which is the largest exchange, and so called 'long format' report and futures only which is in the left hand column. Fig 11.34. Click on this and it will open the report for the latest week.
Fig 11.34
As you will see when you start to do this analysis for yourselves the report covers a wide range of commodities as well as currencies, and the CME report always starts with milk! As shown in Fig 11.35.
Fig 11.35
Therefore, we need to scroll down the report in order to find the section on currencies. This section begins with the Russian ruble, followed by the Canadian dollar, Swiss franc, Mexican peso, British pound, the Japanese yen, the Euro, the Brazilian real, the New Zealand dollar, and finally a little further down the report comes the Australian dollar.
Let's take a closer look at one of these reports before moving on to how to find the other data that we need on the same site.
In this case I've taken the Australian Dollar (Fig 11.36) as an example, but all the other currencies will be presented in exactly the same way. I apologise for the poor quality of the image, but this is taken directly from the CFTC site where as you will see, the quality of text is poor.
Fig 11.36 Australian dollar
The top line tells us it is the report for the Australian Dollar and the CME and below we can see we are looking at the futures only for the date.
The first piece of data we want to focus on is on the left hand side of the table, and in the second column where we have the word Total. Immediately below its says Open Interest.
What we are looking at here is the total number of futures contracts on the Australian Dollar which were open when the data was recorded the previous Tuesday. Open interest simply means contracts that are open or live.
In this case we can see that on the 22nd January 2013 there were 208,776 open interest contracts on the Australian Dollar at the CME on this date. Immediately to the right of the words “open interest” we have two headings. The first says non commercial and the second commercial and beneath these headings we have the words 'long' and 'short'.
Please IGNORE the heading entitled 'spreading'.
Below the long and short headings are the numbers, and in this case we have 143,776 and 46,765 for the non commercial, and 21,291 and 141,610 for the commercial respectively.
The terms 'Commercial' and 'Non Commercial' refer to the broad class of futures traders, with non commercial simply meaning those large speculators and commercial hedge funds who hold positions in the futures market for themselves or their clients.
The commercial group would be the banks who are holding positions for their clients,
generally as a hedge against future currency transfers for goods and services and therefore not
buying or selling as a speculative trader. They are there simply to hedge their clients against currency risk. For me, this latter group is of no interest, as the contracts have been placed with a neutral view of the market and with no bias whatsoever.
Finally, on this line we also have the 'non reportable' grouping which is the small retail traders who are generally wrong and are sometimes used as a contrarian indicator as a result!
In my opinion the only group to watch is the non commercial group as this is the group that buys and sells on a purely speculative basis. These are large professional groups trading large contract sizes.
Therefore, the ONLY data that is of interest to us in each report and for each currency is as follows:
1. The Total for Open Interest which in this case is 208,776 2. The Non Commercial Long – in this case 143,776
3. The Non Commercial Short – in this case 46,765
These numbers on their own tell us very little, but the key point here is to compare them with the previous week's figures, and against the figures for the weeks further back. This exercise allows us to build up a picture of the changes, week by week.
The total open interest figure is telling us whether futures trading in the Australian dollar is rising or falling, in other words it is a measure of volume.
For example, if the Australian dollar is rising strongly on falling futures volumes then clearly this is an anomaly and we need to look elsewhere for an explanation.
Alternatively, we may see a large build up in open interest with very little price movement, possibly telling us the market is weak at this level.
This rise and fall in volume in the futures markets for the currency, will then be a function of our volume analysis which I cover later in the book.
Next we consider the difference between the long and the short position, which in this case would be 143,776 – 46,775. In other words, the market at the moment is heavily long the Australian dollar – net long 97,001 contracts. This is often the figure you will see reported in the financial press, where a currency is net long or net short. This is generally the figure that is being referenced
Over time you will start to build a weekly picture of this difference, which in turn will also tell you whether this is a high medium or low figure. In other words, where the currency is in relation to an extreme in the futures market. If the currency is strong and this is an extreme net difference, then this could be signalling a turning point in the market. The same would be true at the bottom of the market where the difference would then be net short.
Moreover, the reverse is also true. If the net difference is low there is no market bias, and the currency may be set for a period of consolidation. In other words, the professional money is neutral on the currency. However, once this starts to shift, either to the long side or the short side, then this is signalling the sentiment of the professional money – information we would be foolish to ignore.
Therefore, each week we look at all our currencies and pick off the weekly figures to check two things. First, the sentiment for the currency as shown by the non commercials and, second whether there has been any significant shift in sentiment, as indicated by a shift in the net long or short position.
If there has been a significant shift from net long to net short – we ask ourselves – why? Then check our price charts and our other indicators of market sentiment and analysis If there has been a shift from long to short, has net sentiment increased in one direction dramatically or stayed much the same? Again, we check our price charts to confirm.
Finally, is the open interest volume rising or falling and how does this compare to the price action on the chart. Does it confirm the price action or is there an anomaly?
For new traders this may seem a little overwhelming, but in fact all you are looking for is three numbers:
1. The total Open Interest
2. The Long numbers for the Non Commercial group 3. The Short numbers for the Non Commercial group
From there you simply do this for each currency and it is done. It takes a few minutes on a Friday evening as you wind down at the end of the week!
Finally, of course, you will need to build up some historic data as you construct your own simple spreadsheet of figures and these can be found as follows:
Simply scroll back up the page, and in the left hand sidebar you will find a secondary menu below the first, with a tab called 'Historical Viewable' (Fig 11.37) . Click on this menu link and you will find the legacy reports going back several years.
Fig 11.37
If you think this analysis is only for longer term traders. Please think again. What this data is giving you is market sentiment for a hugely influential group of traders. And if they are net long, then as an intra day trader, would it not be better to be trading with them or against them?
Provided all your other analysis suggests the same.
I cannot stress this too strongly. Trading is all about quantifying risk, and if this simple piece of analysis helps to reduce the risk on a trade – great. For longer term traders it is self evident.
This is a powerful item of data to use.
However, the COT report is far from perfect, and the COT report has many critics. These critics argue that it is worthless as it is always out of date by at least 3 days. My own view is different.
I accept its imperfections and would never make any trading decisions based purely on what it is telling me. Rather, it is a simple piece of analysis which I do each week, as it builds into a longer term picture.
The COT report does not give buy and sell signals, but like many of the other techniques and principles I have explained in this chapter, provides a framework against which we can assess market sentiment.
With the COT report, with all its flaws, we at least have a mechanism for seeing the
professional money flow in a pure market. Whether they are right or wrong is, of course, a point for debate.
Nevertheless, this is the professional money we are watching, and is more likely to be on the
right side of the market than the small non reportable positions of the retail traders. However, this is a conclusion you have to reach yourself. All I can do here in this book is put forward the case and explain how to find and use the information which I believe is relevant, to both intra day and longer term traders.
In the next section of the book we are going to move away from relational analysis and focus on the fundamentals and economics that drive the global economies and currency markets.