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Saturday, December 29, 2007

The Commitment of Traders Report: Who is Commited to What? - Part II

In Part I, we discussed the Commercial Interest, their reasons for engaging in the Futures Markets, and the fact that the COT (Commitment of Traders) Report plots out their position each week, which can be graphed over time. At the same, we discussed how difficult it is to tell why the Commercials are in their net position.

Who else are included in the COT Report? A group called the "Large Traders". These are people who have no need for the actual commodity itself, but deal in hundreds of contracts at a time. Your Goldman Sachs. Your J.P. Morgan's. Your Morgan Stanley's.

In other words. Not us.

Where are we at? The group deemed "Small Speculators". Folks who are dreaming of riches and wealth and get involved in the Futures market to attain these dreams. But there is one little fact you should be aware of when it comes to the Small Speculators.

They are nearly always wrong.

I mean honestly, it's amazing. A small speculator can usually screw up the absolute best of situations. They always come in late to a move, or they come in too early. The vast majority of people who engage in Commodity Futures speculation lose money. Over and over again. Such ones generally fail to understand that Commodity Futures is a zero sum game. As you look over the reports each week you will notice that each side balances out the other. When you add the Large Funds together with the Small Speculators, you will notice that this number is exactly equal to the number of Commercials. And the Commercials have the majority of the funds, and the majority of the news. So if your money was going to be on one group? Who would you rather go with, the Commercials? Or the Small Speculators?

Well first of all we have to see this data plotted out for us. One site I personally use and recommend, is Timing Charts. For each commodity that you select, it plots out the COT Data at the bottom of the chart.

So, we come back to our original question. How do we use the COT Report? How can we go with the 'smart money' or the Commercials? How do we understand when they are giving us a 'mass signal'?
  1. Look for a situation where the Commercials are in an extreme position, and use this as an early warning that a such a move may occur. Since the Commercials so often hedge their positions, simply because they are net short or net long doesn't tell us anything. So when we say 'extreme position', we mean, look for situations where the Commercials are more short, or more long, than they have been in a year. If they are extremely short, then a possible short move is on it's way. If they hold more extreme long positions than they have in a year, then a possible bull move is on it's way. But it is vital to remember that the Commercials are usually weeks ahead of time. It's not an exact timing trigger. It's more of what we call an 'early warning system'.
  2. Look for a situation where the Commercials are exactly opposite the Small Speculators in such an extreme position. This is how trading guru Larry Williams who is deemed the expert on the COT Report once put it: "It is critical to look for a juxtaposition between the two group's positions. It is very desirable for both to be at opposing extremes in their positions. The position of the Commercials and Public is bolstered if they are at 12 month extremes in their positions. It is desirable to see the Commercials the most bullish they have been in 12 months, while at the same time the Public is the most bearish they have been in 12 or more months. This is an ideal Commercial / Public "set up" for a bullish move in the market."
  3. It is once again, vital to use this tool as you would the Accumulation / Distribution tool. It will not time the move for you to the day. It will however, show you were the 'smart money bias' is at.
And there we have it. The COT Report, and how we use it in our trading. So how can we put all of this together? Well, as a matter of fact, just such a situation has been brewing. I will discuss this situation tomorrow. It just may mean our first trade . . .

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