If you're trading one of the major equity indices, government bonds, foreign-exchange rates or commodity products, a great source for finding out who is doing what is the Commitments of Traders (CoT) Report. This report is published every week by the US Commodity Futures Trading Association, a government watchdog for US futures and options markets. It presents a detailed breakdown of the positioning of the various major players across a wide variety of traded products.
The CoT report essentially groups traders into three categories: commercials, non-commercials and non-reportables. Commercials are those who use the product in question in the course of their business. In the wheat market, for example, a big food producer who uses futures to guarantee their future prices would be classed as a commercial.
Non-commercials are the big players who trade in derivatives in pursuit of speculative gain. An example of a non-commercial would be a large financial institution that traded crude oil futures. Finally, there are the non-reportables, who are made up of smaller players in the market, including private traders.
The majority of trading is done by the commercials and non-commercials, who together account for as much as 90 per cent of activity in some markets.
There is useful information to be gleaned from observing the positioning of all three categories of trader. A couple of studies have shown that the commercials are the most useful when it comes to determining opportunities, followed by the non-commercials. The non-reportables are, by contrast, useful as a contrarian indicator: they're very often wrong, so it pays to do the opposite.
To measure the activity of one of these groups, we take all that group's long positions and subtract all its short positions. The resulting figure shows us that group's net positioning. For example, in the week of 7 August, the commercials were long of 242,844 gold futures contracts, but short of 395,208 gold contracts, thereby giving a net short positioning of 152,364 contracts.
The fact of the commercials - or any other group - being net short is not, in itself, a reason to be bearish. In fact, commercials are very often naturally net short of the commodity in question. For example, a copper producer might be net short of copper futures today in order to hedge tomorrow's profits. Where their net positioning - be it long or short - is most relevant is when the reading is at or near extremes.
When the commercials are extremely net long of a commodity, it often gives way to a big market rally. When they are extremely net short, it can give way to significant declines. There's a good example of this in the accompanying chart of gold. You can download this data for free every week at http://1.usa.gov/RNDpEd. And we'll be including analysis of this information regularly going forward in our Trader coverage.
