Forex Trading Tutorial: Using COT to “spy” on the market uncover profitable opportunities
Ok, so I introduced you to different tools to uncover the sentiment and imbalances in the market so that you get the direction right for your trades. Let’s cover one of them in more detail in this forex trading tutorial: the COT report data (“Commitments of Traders” report). This positioning data allows you to make sure that you’re following the correct long term direction and understand when a change in direction of price action is just a small pullback or actually the beginning of a new trend. Getting clear on this is essential to make money trading forex
Let’s take a look at a typical COT chart from TimingCharts.com If you notice, below the forex price chart, there are lines with three different colors. The blue line represents the net number of commercial contracts in the market. The green line represents the net number of large speculator contracts in the market. The commercial traders are the big import/export companies that need to exchange currencies on a regular basis to do their business. These are companies such as British Airways, who needs to buy planes from the US and Europe and pay in Dollars and Euros by exchanging British Pounds. The large speculators are banks and hedge funds who are speculating on how the relative economics between two countries are going to play out and thus what the exchange rate is going to look like in the near future. The difference between how long and how short the commercials and speculators are is the “net positioning” of the market (displayed in red) and is usually indicative of the current momentum and sentiment of the market. Your job is to align yourself with this and other driving forces to maximize your ability to make money trading forex.
Euro price chart with COT positioning data beneath (click to enlarge) Image courtesy of TimingCharts.com
Notice how there’s a zero line in the middle. When net positioning is above the zero line and especially if its climbing, buying interest (i.e. postive sentiment) usually exists for the currency. If on the other hand, it’s below the zero line (especially when it just crosses), sentiment is bearish on the currency. Your goal for positioning yourself with sentiment is to buy when net positioning (a.k.a. “open interest”) is well above the zero line and preferably even climbing, and have a selling bias when the opposite occurs.
Notice that when the red line was well above the zero line (Sep-Nov), the Euro climbed strongly on positive sentiment. Then the net positioning started to become less and less long as it proceeded toward the zero line.
Then, in the month of November, the Euro tried to make a new high, yet COT was flat and even slightly decreasing. This divergence signifies a negative imbalance. Remember, to make money trading forex, you can look to trade in the same direction as sentiment, but even better is if you spot an imbalance that drives a powerful, sustained move as seen in the above example.
In the following month, net long positioning (in red) started unwinding fast as it moved toward zero and then became negative by January, at which point the Euro declined sharply in value against the Dollar. This was clearly reflective of negative sentiment. Admittedly the timing wasn’t perfect as price started falling before net positioning went negative, but it was already declining, and that’s why we have other methods of gauging sentiment to complement it (such as currency strength/weakness and price reaction to scheduled news events). I just wanted to show you how things really are, instead of just painting idealistic pictures!
Now you have learned in this forex trading tutorial how to use COT to gauge whether sentiment is positive or negative and if price is ready to make a move or reverse its trend due to an imbalance ready to be unwound.
9 Responses to “Forex Trading Tutorial: Using COT to “spy” on the market uncover profitable opportunities”
August 8th, 2010 saat: 2:54 pm
HOW DO I GET THE “NET POSITIONING” INDICATOR?
August 11th, 2010 saat: 2:24 am
Hi Daramola,
The net positioning indicator is just the red line on the COT chart included below the price chart of each instrument at timingcharts.com I hope this helps, Kris
August 26th, 2010 saat: 9:20 pm
Kris, goodevening…
I was even wishing I can meet u after I finished reading this text.
It was very educative.
I liked it because you are speaking from a different perspective and just like an insider.
Can the COT chart be placed on my platform, just like an indicator?
Please, kindly reply this message to my mail box (forexclues@gmail.com)
Thanks in advance.
August 27th, 2010 saat: 8:59 am
great work chris. u’re highly appreciated. love u.
August 28th, 2010 saat: 3:52 am
Hi Lawal,
Thanks for your very kind words. It means a lot. Regarding COT, yes it can be placed in the MT4 platform as an indicator underneath the chart, but you need to link it to a data source since the information doesn’t come from price like most indicators. Search for “COT indicator metatrader” or “COT indicator MT4″ and see if that comes up with anything. I’ve seen this one site that charges $5 month but you don’t have to update the COT data manually which is nice. Forgot the name.
Kris
August 29th, 2010 saat: 5:13 pm
hi chris, once again u’re highly appreciated. am a day trader and my problem now is simply that am trying to combine this strategy of urs regarding COT together with the one u gave us on buying/selling ahead based on the economic calendar forecast which in my own discovery, this may sometimes be regarded as counter trading which many dnt support (though my favorite delight trades. to cut this story short, what i want to bring out is that can i take the advantage of counter trade (as a day trader using the economic calendar in line with ur recommendation of buying between12-36 hours before the actall release) even when the daily net positioning (red line) is reading negative sentiment. the reason why am asaying this is because manu atimes, the only oppotunity one gets to make profit on a daily basis is to take the counter trade offer. i want to believe my grammer is clared enough for u to understand. if there’s anything not clear enough, i’ll be glad to put more effort to explain what i meant. thanks as i await ur reply.
August 30th, 2010 saat: 10:45 am
Hi Kris,
Sorry to take you back on COT issues.
Please can u tell me the reason why large speculators(Banks and hedge funds) are doing the opposite of what the commercials(importers and exporters) are doing?
In other words, why the blue line is in the opposite direction of the green line?
I understand that the important line here is the red one.
Thanks in advance.
August 30th, 2010 saat: 5:02 pm
Lawal,
Great question. You have to keep in mind that the speculators and the hedgers have different goals. The speculators want to make money from the FX market. The hedgers don’t care whether they make or lose money in FX: they just want to protect their import/export prices. So what happens is, as the large speculators build up long positions, they accumulate so much currency that the supply goes down (hence price goes up). The hedgers are happy to sell on the way up as they are able to sell at higher and higher prices. Besides, these large traders always need someone else on the other side of their trades, so the trends are likely to represent reflections of each other.
Thanks for the great question, Lawal.
Kris
August 30th, 2010 saat: 5:05 pm
Hi Adebayo,
Sure, what you’re describing is possible, however consider this: The COT indicator should be looked at as a directional indicator for longer time frames (at least weeks at a time). If you are using it for day trading it won’t help you.
Doing contrarian trades by entering before news is a profitable strategy but make sure your contrarian trades are against the short term trend but in alignment with the longer term trend governed by sentiment.
Kristoph
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