How to Read the COT Report and Use It in Forex Trading?
The Commitment of Traders Report, or COT report for short, is made by the US Commodity Futures Trading Commission (CFTC) and released every Friday at 15:30 east coast time.
Its significance lies in the fact that it gives a unique look into what are traders doing all across the market. And, knowing where most Forex players are standing when creating a trading strategy.
There are three main groups in the COT report:
- Non-Commercial Traders: This group is comprised of speculators. Specifically, large institutions that are currently speculating in futures markets. For example, a private fund opening a position on EUR futures because they think the US will weaken.
- Commercial Traders: These are all the multi-nationals hedging in the futures market. For example, Tata hedges its cost of production due to changes in forex prices by opening USD/INR futures contracts.
- Non-Reportable Traders: The last group is where all the small traders fit. And, while these group may rarely be prominently reflected in the COT report, it is also of notable importance for analysis.
Knowing the groups is nice, but what matters is what a trader can do with such information. These are the most common ways top-traders use the COT report.
As a volume indicator
Conservative traders look at the COT as a way to check if the volume traded compliments use technical analysis. This type of trader will avoid making a move on a pair if the COT signals something opposite to what their study suggested. So if this trader is expecting a rise, they should see also a growth in the open interest. Likewise, the same will be valid for a fall.
It is a very safe strategy that tends to produce positive results consistently, but it also leads to some big misses.
Taking advantage in reversals
More risky traders look at the COT and look for ways to go against the grain. To anyone considering this path, it is not for faint of heart. There is a high risk when you are betting against the position taken by a large part of the market. That is why most traders interested in doing this hedge their bets by opening positions in uncorrelated pairs.
That said, there is no denying that following this strategy will yield high dividends.
Traders are using the COT report to understand Fx positioning which is correlated with major currency trends
Following the trend
Those who are not super conservative but are not extreme risk takers either, look at the COT for guidance. It is a solid strategy with little downside. However, it does have little upside as well. Due to the nature of the report, it is impossible not to have a USD-heavy portfolio if the COT is used to build a forex trading portfolio. Moreover, the revenues are relatively small, since all a trader is doing is following the trend.
Overall, it is a safe but not ideal to use the COT as a means to build a portfolio. The goal of any trader is to be as neutral as possible, so to avoid overinvesting in a single pair due to over-commitment.
The COT report is a powerful tool that gives any trader the flexibility to follow different paths when creating their trading strategy. The most important part is to remember that the COT data is another tool and shouldn't be used alone when making a trading strategy.