TO COT OR NOT TO COT, THAT IS THE QUESTION?
I mention the COT data alot in here and there was a question or two that came recently about this stuff, so I thought it would be a good topic for today. The above chart is GOLD with the COT data displayed below. There are basically 3 guys I know of who have written books about the COT data, Larry Williams, Steve Briese, and Floyd Upperman. Larry was the first to write about this and teach it to students, Briese came second with Upperman some time afterwards. The first two gentleman I know, the third I do not, so I can only speak about his book. I believe that Larry has the most knowledge, he has studied it the longest and I think but cannot be sure, makes the most money actually trading off this information. However, any of the three sources have good reviews of the data in their books on the subject.
Many software vendors now provide this in a formatted version. The above chart is Genesis, but I also have Trade Station who has it as well. For those looking for it free, I doubt you will find it but who knows. You can certainly undertake downloading the information and manually working with it yourself but I think that is penny wise and pound foolish.
The report categorizes activities into three categories: Small Speculators, Large Speculators, and Commercial Hedgers. I also have Open Interest displayed.
In general this is how to look at the categories. Small Specs are the small money and normally we want to fade their activity. History has shown repeatedly heavy long positions in them at tops and short positions and bottoms. This makes sense if you think about it, once the small investor finally piles into something it is usually a top. Although the above chart in Gold where I have highlighted this condition has shown one instance after another where this old adage has failed to work, in general it has worked quite well across all markets for quite some time. This is an anomaly.
The second category, Large Speculators are the funds. They are the trend accelerators who generally buy more on strength and sell more on weakness, momentum players. Both the Small and Large Specs have position size limits, they can only put x number of dollars in one direction. The reason for this is that the government does not want someone cornering a market, ala the Duke Brothers or the Hunt Brothers in a real life analogy. In general but not always, we want to trade in the direction of the Large Traders since that is where the trend usually is.
The third category is that of the Commercial Hedgers. These are the actual producers of commodities and their general function is to hedge their bets in the markets against that production. The futures markets were originally formed for this reason. They have unlimited position size allowances due to this function and are generally the smart money in the game. Our general rule is that we want to follow what they are doing because they have the most money and the most knowledge. However, the one caveat to this and it is a very big one is this, they are counter trend traders in general due to the nature of why they engage in this activity to begin with. We have to be careful when there is a large trend underway about fading it when the Commercials invariably take the opposite side of the trade. You can certainly see examples of this in the Gold chart at the top. Keep in mind if producers are locking in forward production at great prices, that does not necessarily mean we should be shorting the move. It is a business function they are performing.
I have made some snide remarks about how the COT data has jumped the shark recently. What I was referring to was how the time tested strategy of fading the Small Spec extremes has not worked at all in recent months. I have my ideas about why this is true, but that is a subject for another time. The net of all of this is what I have marked on the chart with the arrows below retracements against the uptrend where the Commercials bought the dips. This is what you should be looking for in general. When you get hedgers willing to bet heavily in the direction of a trend, it is very powerful, and you can see the moves that take place when this happens.
COT stuff in general is more larger picture, "where should the next large move go" type of analysis. You cannot use this on a daily basis, it is reported weekly. You can play around and create daily indicators that mimic what the commercials are likely doing on a daily basis, I have done this. I am not sure how valuable that is to be honest, although it is something I constantly am studying.
If we look at where we stand right now with the COT data in regards to this market we are in neutral ground. Most of the players have middle of the road positions so that does not tell us anything. They did buy the minor dip a couple of weeks ago and you can see that up we went as a result. At the moment the trend is up and the COT stuff does not indicate otherwise, so there is no reason to be looking to short this market here other than whatever daily or day trading techniques someone might be using. Strictly from a trend or fundamental standpoint, there are no sell signals.
As to current setups, all I am looking at today is a long in Coffee which at press time does not appear to be a likely fill but you never know. I don't see anything else to be excited about today. Study the COT data for yourself, maybe you will find an approach different from what I described here that works better.