Commitment of Traders Report

The Forex market is a global, decentralized market that is traded “over the counter”. An over the counter (OTC) market is where financial instruments are traded directly between traders and dealers. As an OTC market, the Forex market has no central exchange or clearing house that records and shows what trades are being carried out, making it difficult for Forex traders to get a handle on the volume of currencies being bought and sold in the market. This information is useful to know for both fundamental and technical analysis, and determining what trades to make and when to make them.

However, while most retail traders trade foreign currencies over the counter, the big financial institutions and large fund managers tend to buy and sell currency futures. A foreign exchange futures work in the same way as futures of other financial instruments; it is a contract to exchange once currency for another at some point in the future, for a price that is agreed at the time of the contract. Forex futures are traded on a regulated market, which means information regarding the trades is publically available. This article explains how that information is made available, by way of the Commitment of Trading Report, and how that information is useful.

What is the Commitment of Trading Report?

The futures market for foreign currencies is regulated by the Commodities Futures Trading Commission (CTFC). The CTFC require active traders of significance in the market to make weekly reports on their positions. This data is then compiled by the CTFC and used to make the Commitment of Traders report (COT). The COT reports shows what positions have been taken by traders and can therefore act as a substitute for information relating to the volume of currencies being bought and sold. It can help show how bullish or bearish traders are in the market and this can be used to help predict future movements in the Forex market.

The COT report is made up of three main sections – commercial, non-commercial and non-reportables. Commercial trades are those made for business purposes. For example, a large company that exports its products globally may trade currency futures to hedge against shifts in currency values that could affect its income. Non-commercial trades are those that are made for speculative reasons. These trades can be made by banks and other large financial institutions, big individual investors and even governments. It is these trades that are of particular interest to your average Forex trader. Non-reportable trades can be largely ignored – these are trades by those that do not have to report their positions to the CTFC. They represent a small percentage of all the data reported in the COT and don’t have any significant influence.

There is a range of data contained in the COT report but there are three particular points of interest; the disclosure of open interest, short interest and long interest. Open interest is the number of contracts that are up for sale, short interest is the number of contracts owned for short selling a currency and long interest is the number of contracts owned for taking a long position.

Knowing about the Commitment of Traders report and understanding the information contained in it is one thing, what is particularly useful is knowing how to interpret the data and act upon it.

How to use the Commitment of Trading Report

It is accepted that buying and selling patterns matter, in any financial market, as ultimately the price of a financial instrument is driven by supply and demand. The number of people buying, the number of people of selling and how much is being bought and sold is all relevant to making predictions about the directional movement of a financial instrument.

In the Forex trading market, the COT report can be used to determine what is being bought and sold. Specifically, the COT report can help Forex traders find the tops and bottoms of trends by examining the price at which currencies are being overbought and oversold. When a currency is being overbought or oversold, that is usually the sign that a trend is about to come to an end and the market will see a reversal.

In using the COT report to help make decisions about which way a market may move, it is important to recognize some key points. Firstly, it is not the actual numbers shown in the COT that are of importance, it is their relation to each other. If the number of short interest contracts increases from 30,000 contracts to 50,000 contracts, that doesn’t necessarily mean anything by itself. The number of long interest contracts could have increased by the same amount, which doesn’t really provide any information. What is relevant is the proportion of long and short interest to total interest.

Secondly, it should be recognized that Forex traders often follow the market and back a currency to continue moving in its current direction. As a bigger and bigger percentage of trades go in one direction, the price is obviously pushed further in that direction. However, there comes a point when the momentum cannot be kept up. For example, when the vast majority are going long on a currency and it is continuing to rise, then there will eventually be a point when traders begin to go short and the trend will start to reverse. It is possible to use the information contained in the COT report to make a judgment on when that tipping point will be reached.

Finally, note that non-commercial traders have the most significant role in the market. Commercial trades should not be ignored, but it is the non-commercial trades that you should watch for big swings. When short and long interest is relatively equal, the market is showing no particular signs of bias. However, when one interest starts significantly increasing in relation to the other, that is the sign of some momentum in the relevant direction. When that interest starts reaching extremes in terms of its ratio to total interest, it could be a sign that the market could soon begin moving in the opposite direction.

Summary

The Commitment of Traders report comes out once a week and contains useful information regarding the activity of traders in the Forex futures market. By studying this data and looking for significant changes in the activity of the non-commercial traders, it can be possible to identify the beginning of a trend. More importantly, the data can be interpreted to signal when a market is being overbought or oversold and a reversal is likely.