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Weekly Contrarian COT Index and Retail Positioning Analysis

Submitted by Pivotfarm on 10/10/2010 14:00 -0400

The Commitment of Traders Report is created by the CFTC – The Commodity Futures Trading Commission and is published weekly every Friday. This body gathers and publishes the open futures positions on all publicly traded US futures contracts as well as the corresponding options. The data consists of 3 main categories.

Commercial Traders – These are the bigger players in the markets, the smart money and consist of large firms that actually use the commodity being traded, includes companies like…BP in the Oil and Gas Market, Nestle in the Cocoa and Sugar market. The main function of these traders is to hedge the price of the commodity that they trade in.

Large Speculators – These consist primarily of commodity fund traders and are mainly trend following. The position sizes of these traders tends to be in tandem with the movement of price.

Small Speculators – The little guys, individual traders and small firms, these are the traders that tend to be wrong in the market at the tops and bottoms of markets.

How do we use this data? We believe that the COT Index offers a good indication of market sentiment and future direction. The key is to follow the smart money (Commercial) and trade against the other 2 groups when they are at an extreme.

Extremes in the data are figures below 30.00 and above 70.00. The ideal situation for a short position is a low reading in the Commercial COT and high readings in the Large and Small trader numbers. For example the Commercial COT Index reads 5.97, this means that the net commercial position is strongly biased to the short side. The Large and Retail (our main contrarian focus) are reading 97.70 and 100.00 respectively, meaning they are the most long side biased they have been in the last 6 months. For traders this means that their focus should be on short side trades, the goal is to follow the commercial traders when the other 2 groups at opposite extremes. This is the ideal alignment of the groups for optimum success.

This weeks COT Index Review

e-mini S&P 500: We’re seeing a continued weakening of the Commercial long position, along with weakening in the Large/Small trader short position. Although we still have 2 green lights we would urge longs to be cautious.

Signal: Moderately Bullish

EURUSD: No let up at all in the buying strength with the Euro, all groups remain at 6 month highs/lows, presenting the ideal bullish set up.

Signal: Bullish

GBPUSD: COT positioning with the pound is identical to the euro and last week became the strongest it had been in 6 months.

Signal: Bullish

USDJPY: The Bank of Japan will need some stronger measure to halt this runaway train. Commercials are back to almost 6 month lows in Commercial short positioning.

Signal: Bearish

Retail Trader Position Analysis

Also known as the Long-Short ratio this is a tool primarily offered by Forex firms, we haven’t been able to come across the same data in the futures as yet. The data is based upon the collective trades and trading direction of many thousands of retail traders (the average Joe). This group of traders is notoriously wrong at predicting market direction, market tops and bottoms with some simple analysis we can look at this data and take a contrarian view, for example if over 70% of retail traders are long USDJPY this offers us a short bias. Savvy traders should then be focusing there energies on short side trades.

USDJPY: Retail positioning still remains 80%+ to the long side. This extreme positioning has been the picture painted with the USDJPY for many weeks now. Doesn’t look like its ending any time soon, major intervention measure will be needed to push for a change.

EURUSD: Retail traders have continued a short bias despite a powerful up trend in the euro. The short bias did however soften at the end of last week.