How to read the CoT report and gauge investor sentiment
The CoT report is a weekly report released by the Commodity Futures Trading Commission that breaks down the open interest for each major futures market.
When trying to analyse bullish vs bearish sentiment in commodity markets, traders like to look at the CoT (commitments of traders) to get a feel for overall investor sentiment
We are looking at the history of this indicator and how it can help investors gauge market sentiment.
The history of the CoT report
The history of the CoT report goes back to 1962, a time when commodity futures markets were in their very beginnings. Since then, the Commodity Futures Trading Commission has released the Commitments of Traders report every week.
What is the CoT report?
The CoT report shows the aggregate positions (open interest) of three different groups of traders: commercial traders, non-commercial traders (also often referred to as 'large speculators'), and non-reportable traders (anyone not belonging to the other two categories).
The data is a way to gauge market sentiment, as large speculators and commercial traders are typically more informed and have more money at stake than small traders.
The report provides information on the open interest of futures contracts for several different commodities. It is seen as a valuable tool by traders, as it can provide insights into the market sentiment for a particular commodity. For example, if the open interest for a commodity is increasing, it may be an indication that traders are bullish on the commodity.
The CoT report covers several different commodity futures markets, stock index futures, and volatility futures. A good picture of its coverage is available on the CFTCs' website, with data dating back to 1985.
On Barchart.com, the CoT report can be accessed for various commodities and indices and is displayed beneath the price chart.
What insight does the CoT report provide?
The CoT report shows the total number of open contracts for each commodity and the number of contracts held by commercial and non-commercial traders. Commercial traders are typically businesses that use futures contracts to hedge against price fluctuations in the commodity they are trading. Non-commercial traders are typically speculators who are betting on the future price of the commodity.
The CoT report can therefore be used to understand how bullish or bearish traders are on a particular commodity. For example, if the number of non-commercial contracts is increasing, it may be an indication that speculators are betting on a price increase. Similarly, if the number of commercial contracts is increasing, it may be an indication that businesses are hedging against a price decrease.
Bearish vs Bullish sentiment in the CoT report
The CoT report can be used as a contrarian indicator. Extreme bullish positioning of uniformed speculators indicates that the market sentiment is overheated.
With commodities, it is assumed that commercial traders have an information advantage about where the market is headed because they are the closest to the actual underlying market developments. For example, think about a large wheat producer in the United States: this company probably has the best knowledge of the status of the wheat market, such as the potential of the upcoming harvest. If they are expecting a good harvest, they typically would expect declining prices and thus would be selling futures contracts.
In this case, their positioning on the CoT report would be reported as ‘net-short’ and indicate bearish sentiment.
Positioning of small speculators (non-reportable traders)
Small speculators are generally viewed as the 'least informed traders'. They are more nimble and can react quickly to changes in the market. A high net long reading on the CoT report can be used as a contrarian indicator, meaning that if they are heavily long, it may be time to start taking profits, and if they are heavily short, it may be time to start buying.
Positioning of commercial traders and non-commercial traders
Commercial traders are typically producers or processors of the commodity who use the futures market to hedge against price changes. Non-commercial traders include speculators who trade for profit. The report can be used as a valuable market sentiment indicator to gauge the feeling of market participants. A large build-up in non-commercial positions may be an indication that speculators are bullish on the market and are expecting prices to rise. Conversely, a large reduction in non-commercial positions could signify that speculators are bearish and expect prices to fall.
How can traders use the CoT report?
The CoT report can be a useful tool for traders, amongst other popular analytical methods like stock sentiment analysis.
First, it can be used as a way to gauge market sentiment. Suppose there is a large number of contracts held by commercial speculators. In that case, this could be seen as a bullish sign, as they are typically considered to be more informed and sophisticated than other participants in the market.
Second, the CoT report can be used as a way to identify potential trading opportunities. If speculators hold many contracts, this could be seen as a sign that the market is overbought or oversold and that a reversal may be imminent.
Finally, the CoT report can be used as a way to monitor risk. If the number of contracts held by speculators is increasing, this could be seen as a sign that the market is becoming riskier and that traders should be cautious.
What are the limitations of the CoT report?
While the CoT report can be useful for identifying potential trend reversals, it is important to note that it has several limitations.
First, the CoT report only covers a limited number of markets and, therefore, may not be representative of the entire futures market. Second, the report only provides information on the net positions of large traders and does not provide any information on the positions of small traders.
Third, the report is released on a weekly basis and, therefore, may not provide timely information on market movements. Finally, the CoT report includes data from the previous week, which means that it may not reflect the most recent market activity.
