What is the current market view on Gold? How are positioned the largest speculators in Oil? This article tries to exploit all these information thanks to a useful tool, known as the ‘Commitment Of Traders’ report. The main goal is to develop a passive trading strategy based on what the ‘Sharks’ are currently doing in the market, rather th an to build an in-house view based on the classic information included in prices, volumes and any economic or political factor. The idea is rather simple: since, as retail investors, we can’t predict or influence the future behaviour of prices, we try to analyze the movements of those who actually are the ‘strong hands’ in the market and try to operate accordingly, that is a “rem ora-fish” strategy.
Fortunately, all the information related to the largest players positioning are public, and are released weekly by the U.S. Commodity Futures Trading Commission in what are called the ‘Commitment of Traders’ reports (COT). The origins of the COT track back in 1924, when the U.S. Department of Agriculture’s Grain Futures Administration published its first comprehensive annual report of hedging and speculators in regulated futures markets. As time has passed the publication frequency has gradually increased to monthly (1962), bi-weekly (1992) and finally to weekly in 2000. The reports are now released every Friday at 3:30 pm ET and refer to data collected the last Tuesday for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the Commission itself. They are available in short and long format and include the Traders in Financial Futures (TFF) reports, the Legacy COT reports and the Disaggregated COT Reports for Physical Commodities . We take as an example the COT Legacy Report published on November 6th 2015 for Futures traded on the CME, looking in particular at the EUR/USD futures contracts.
The report shows the Open Interest (equal to 405,462 contracts) as of Tuesday 11/03/2015 as well as the positions taken by each category of traders (Non-Commercial, Commercial and Non Reportable); in particular the “spreads” measures the extent to which non -commercial traders hold equal long and short futures positions. We are interested mainly in the Net Position (Long – Short positions) taken by Non-Commercial traders, that is all the reportable traders that use future contracts primarily for speculative purposes, since we believe this is the class of operators that are best equipped, best informed and can best give an indication of future price movements. In the chart below we plotted with Excel the Net Positions for Non-Commercial traders (blue histogram) as well as the actual exchange rate for the EURUSD (red line) from 2000/08/29 up to 2015/10/27.
We can easily note what seems a strong relation between the Net-positioning of speculators and the rate movements. We know empirically that flips in Net-Commercial positions can be a signal for trend swings and that the same has been observed for extreme levels of positioning, due to market illiquidity and equilibrium issues (this is the case for May 2007, May 2010, May 2011, June 2012 and April 2015). We tried to run a passive strategy on the EURUSD based on the sign of the Net-Position for Non-commercial traders: every Friday we simply opened, monitored and eventually reversed our position according to the last COT report referred to the previous Tuesday, so that we didn’t even look at the actual spot rate or at any other available information. As of October 27th 2015 a strategy of this kind would have delivered a net return of roughly 128% over the period and an average weekly return of 0.1185%, not accounting for overnight rollover fees.
Another and perhaps more interesting way to use the COT is to actively “trade” it. Taking into account the Disaggregated COT Report for Physical Commodities for the WTI futures contracts traded in the CME we looked at the Net Positions taken by the segment of traders denominated as ‘Money Manager’ and we set up a very basic and common strategy based on Simple Moving Averages (SMAs). The idea is to open a long position whenever the 2-months SMA of the Net-Positioning crosses over the 6-months SMA, and to reverse it as soon as it crosses under, which means to go long whenever we observe an increasing (namely ‘above the average’) long positioning and to go short in the opposite case (this is generally done with prices using SMAs of 5 and 20 periods). Again, we didn’t even look at the actual price; results are reported below and refer to market data from 2006/12/08 to 2015/11/03, as usually positions are opened the following Friday.
Taking advantage of Crude Oil’s higher volatility we got a profit of almost 1003% from the strategy (green line), again not taking into account overnight financing fees (we can imagine to trade the related CFD in place of the actual futures contracts). It is interesting to compare this result with the return of 90.5% we would have got by applying exactly the same strategy on the actual prices (red line). Finally, it can be noticed how both the two strategies have periods of inactivity (flat lines); this has been reached in order to avoid long drawdown periods by using a technique know as ‘equity curve trading’. We first computed the log value of the equity curve generated by applying the strategy in every period, and than we took a 20-periods SMA. We then set the actual strategy to operate whenever the previous value for the log-Equity curve was above its SMA and to stop as soon as it crossed under.
It has to be mentioned that similar tests have been run on several time series of currencies and commodities, obtaining each time controversial results. Far from being the ultimate solution for retail investors, still the COT surely remains a powerful tool for analysing the future market behaviour and to get a clear overview of the ‘Sharks’ swimming path.