COT Forex Strategy: COT net positions & COT Index

The Commitment Of Trader (COT) report provides some positioning information about the futures market and it is one of the most underrated tools that forex traders can make use of to increase their trading performance.

The report is compiled and released weekly by the Commodity Futures Trading Commission (CFTC) in the United States every Friday at 15:30 Eastern Time, and records open interest information about the futures market based on the previous Tuesday. Anyone can access the COT report for free on the CFTC website(www.cftc.gov/cftc/cftccotreports.htm).

COT report usually shows you how the big guns are playing their cards and in my experience it can be used to in different ways to make your trade calls more profitable.

Well, back to COT report and how to use it COT report arrives three days late but the information nonetheless can be helpful since many traders spend their weekend analyzing the COT report. 

The time lag between reporting and release is the main handicap of the COT data, but despite this limitation, you can still use it as a sentiment tool.

In this report you can see the long and short positions held by traders in each of the three main categories defined by the CFTC.These categories are:

Commercial: This group consists of market participants who use the futures contracts for hedging purposes, and these commercial participants are generally exporters and importers who are hedging against currency fluctuations. 

Non-commercial/Large Traders: This group consists of large speculators such as hedge funds, banks and so on who use currency futures just for speculation

Non-reportable/Small Speculators:
This group consists of small speculators like retail traders.

The COT report tells you the long and short positions undertaken by participants from each category.When it comes to analyzing information pertaining to currency futures in the COT report, it is generally more relevant for traders to focus on the noncommercial/Large Traders
participants rather than on the commercial participants. 

The reason behind this is that these large speculators trade the futures contracts mainly for profits, and do not have the intention to take delivery of the underlying asset, which in this case would be cash. 

On the other hand, commercial participants tend to maintain and roll over the same amount of contracts from month to month for hedging purposes even though these positions could be in losses. 

Large speculators, however, will usually close their losing positions instead of rolling them over to the next month.

The COT report allows you to gauge market sentiment in the currency futures market, which also influences the spot forex market. 

Currency futures are basically spot prices which are adjusted by the forwards (derived by interest rate differentials) to arrive at a future delivery price. Unlike spot forex which does not have a centralised exchange at the time of writing, currency futures are cleared at the Chicago Mercantile Exchange.

One of the many differences between spot forex and currency futures lies in their quoting convention. In the currency futures market, currency futures are mostly quoted as the foreign currency directly against the US dollar, so the price quotation is inverse in USDCHF and USDJPY and USDCAD. Please note that difference while analyzing the COT report.

What I use to set up my trade ideas are the net positions held by noncommercial/Large Traders and COT index.

COT index represent the percentage of the current COT net position when compared to 13 weeks range of the COT net positions.(different setting are also used like 26 weeks or 52 weeks but I prefere the 13 weeks).

Trend Following Model Vs Countertrend trades: the net position (long/short) can be used to trade in the right side of the market and COT index extremes can be used to trade the reversals.

Note that COT Index ranges from 0 to 100.Having said that, COT Index reading close to 0 means short extreme and reading close to 100 means long extreme ;therefore a pending reversal would be the trade set up.The Conceptual frame work that I use as trading is 

1-The Set up Condition: decide you want to go long or short (or sometimes just stand aside) based on your analysis.

Here we use COT net positions & COT Index to make our desicion.

2- The Entry: the point you enter the market. I uully do it with use of technical analysis:

1-Break Out scenario: the Support and Resistance Break out. I place pending Sell/Buy Stop Order at predetremined break out point.

2-Buy dip/Sell High (Trend Following Model): I place pending Sell/Buy limit Order at previous Support now turns Resistance point (or visa versa).

3-STOP LOSS: the invalidation point ,which you must get out of the trade no matter what.(based on S/R)

4-Take Profit/Exit Strategy: where you can close your profitable position or you should exit from your position.(Take profit point can be set up in advance base on S/R or Fibonacci extention but you should always watch you trade as the market tends to surprise most of the time).

What I do here are: 
1- to analysis the weekly COT net position & COT index reading

2-to make some trade ideas based on COT analysis (the Set Up Condition) and to suggest entry point (the Entry) based on my own technical analysis.

I try to make the trade calls as pending orders as we all know no one can watch the markets 24/7 (one funny thing is that I had more winning trades this way while I'm sleeping!!) and I try to update the trades which are in progress or being invalidated.
The pairs that I discuss here are EURUSD-GBPUSD-USDCHF (inverse here)-USDJPY (inverse)-USDCAD (inverse) and my all time favorites AUDUSD and GOLD