The Commitment of Traders Report (CoT) is a weekly report issued by the Commodity Futures Trading Commission (CFTC). The report shows existing positions and change of position size for several groups of traders in a variety of futures markets. This data can be found at www.cftc.gov, and is also available for download through data streaming services like Genesis.
Who Does the Report Cover?
For many years, the report included statistics on three major groups, commercials, institutional traders, and small speculators. More recently, each of these groups has been broken down further into subgroups. However, for our purposes, we will focus on the aforementioned three major groups.
Why is CoT Important?
CoT is one of the best leading indicators of long-term trend. Used properly, it can help us decide if conditions are right for a trade. It doesn’t provide a trade “trigger”, that is, it will not tell you exactly when to buy. However, it can give you a “setup”, telling you whether or not the trend is congruent with a trade you’re considering. That is to say, CoT clues you into the long-term trend, making the success of your trades more likely. But we don’t simply buy when commercials buy and sell when they sell. See our notes on application below as well as an applied example at the end of this article.
Is All CoT Data Necessary?
The Chimps do not consider all CoT data equally important. Commercial activity is by far the most reliable data within the report. Remember, these are generally large companies that have spent years dealing day-in and day-out with a few select commodities. Their ability to predict the cost of these commodities, and thus protect the profits of their own business, has been consistent over the course of decades.
There is a lower ability to successfully predict these price moves among institutional traders, and even more so among small speculators. We don’t disregard either of these groups completely, but we give much heavier weight to commercial activity. Institutional trader and commercial activity sometimes diverge, and commercials tend to be right in these situations. Small speculator activity is usually a contrary indicator, but this is not always the case. For these reasons, we don’t consider these two categories particularly reliable, thus we look at them less.
What Stocks Work with CoT?
Since the CoT reports on futures markets, there is a specific subset of stocks with which you can successfully use CoT. Commodities ETFs and ETNs are an obvious choice here, but only those with useful CoT reports. These include crude oil, gold, copper, sugar, coffee, corn, and wheat. Stocks closely tied to the price of these commodities can also be analyzed in this way. Goldcorp and Barrick for gold, Exxon and Gazprom for oil, Freeport-McMoRan and BHP for copper, ADM and Kraft for grains and sugar, and Starbucks for coffee. You get the picture!
There are also stocks that just aren’t suitable for CoT. For example, you can’t use financial futures in conjunction with financial ETFs and stocks. Our extensive backtesting show this approach to be highly ineffective.
Beware: Application of CoT is Counterintuitive
So, buy when commercials are buying and sell when they’re selling… right? WRONG! It may sound confusing, but it’s exactly the opposite. Unless you have the foresight and capital of a commercial, you will get crushed and lose everything if you do the same. For explanation of why, see our notes & cautions below.
Just remember this. For the small investor, buy at the end of commercial buying and sell at the end of commercial selling (with proper setup-trigger-followthrough, of course). Why? The end of commercial buying usually coincides with the start of a bull market. Likewise, the end of commercial selling usually coincides with the start of a bear market. Again, for an applied example of this, see the charts below.
Notes & Cautions
Commercials are Hedgers, Not Speculators
Commercials provide the most reliable data within the CoT, but it’s not always obvious what they’re doing just by glancing at the numbers. When commercials buy or sell, they are not opening a new position, they are hedging. Remember, commercials always have stockpiles of the commodities they trade. Buying means they are protecting themselves against an anticipated rise in prices by locking in a lower price now. Selling means they are protecting themselves against a fall in prices by locking in a higher price now.
Commercials Act in the Long Term, Outliving the Little Fish
Unlike large and small traders, commercials buy into and sell out of gigantic positions over long periods of time. Whereas a trader might accumulate a position over the course of days or weeks, commercials average up or down over the course of months and years. This means that a commercial can remain a buyer in a 15 or 20% move down, while smaller traders would have been stopped out almost immediately. So you as an individual should by no means attempt to mimic the activity of commercials. Instead, use their activity to verify a market trend or time a change in the trend.
An Objective Approach
Here’s an example of an objective approach, using the CoT as confirmation of the long-term trend, then using the standard setup-trigger-followthrough approach on a shorter-term ETF trade.
In this example, commercials accumulate coffee for nearly two years as the price of coffee goes down. We watch the CoT report to time our own buy for the end of commercial buying.
First, we look at a quarterly chart of coffee futures:
This chart illustrates the start and end of commercial accumulation. Note, the end of commercial accumulation is usually the start of a bull market, which is how we time our ETF trade on the next chart.
Next, we look at a weekly chart of JO (the Coffee ETF):
The red line on this chart is the end of commercial buying (same point as on the chart above). End of commercial buying generally signals the start of a bull market. As investors or traders, we do not have the luxury of massive funds to support dollar cost averaging. Consequently, we must apply timing, entering the trade when commercials stop buying.
As you can see, the process of using CoT data for investment-grade long positions is not totally mechanical. Some judgement is required, however, the large profits that are to be gained by following this procedure will offset the fact that, on occasion, several attempts to enter long positions will initially be stopped out.