Originally published in Vantage Point Trading Blog on June 28th, 2017.
How to Use the Commitment of Traders Report in Your Strategy
Many traders assume the stock market to be this single entity which is logical, rational and knows where it wants to go.
The reality is much more complex.
Markets are comprised of a blend of different types of traders. From scalpers, to swing traders to investors. Retail clients to gamblers to institutional money.
One of the most important aspects is to separate the market into two sub-categories: retail money and institutional money.
Retail traders very rarely have the collective power to move a market, and are often just a spec of noise in the large picture. The retail crowd is often wrong, emotional and looses money on average.
The professional money is huge, and when it makes moves it is easy to spot and follow when you use the right tools. Big positions take time to unwind or reallocate. This is why it’s vital to follow the smart money.
Today I’ll discuss one such tool, called the Commitment of Traders report.
What is the Commitment of Traders Report?
Imagine that every time an institutional trader made a trade they reported it.
Now imagine having access to that report for free?
You’re in luck.
The Commodity and Futures Trading Commission (CFTC) keeps track of institutional traders who are registered and manage big money above a threshold.
This data is reported and published weekly on Fridays at 3:30PM EST on their website here:
Each report covers the previous Wednesday to the current week’s Wednesday. This makes the data current, fresh and very useful.
Who can Use this Commitment of Traders Report?
Every trader should be using it!
The CFTC publishes weekly data for stock indices, commodities, currencies and many more products. No matter what you trade, this report can help you.
Whether you are a swing trader or day trader, this information will help you see what the institutions are buying and selling.
This is important information.
How do You Use the Commitment of Traders Report as a Trader?
When you manage multiple millions, you create a diversified portfolio that you need to re-position and reallocate regularly.
Imagine you are a portfolio manager for a minute.
If you think stocks are near highs, you will start to sell stock index futures to hedge your long book, while simultaneously taking the cash proceeds and investing them elsewhere.
The COT report will show you just that.
If you see an outflow of equities, you can then check bonds, gold and the Japanese Yen (safe haven assets) and see if there is an increase. An increase suggests that institutional money is running out of equities and looking for safety in these assets.
If equities were sold, but the cash was not put into any other markets, this can be seen as profit taking. The longer this trend continues, the more cash there is on the sidelines.
This could be a sign that the smart money is waiting for a dip to buy into once the retail traders get stopped out on the downside after buying the top.
Knowing this information as a trader can help you move with the smart money and trade in the direction of strength.
Trading is like surfing.
You swim out to the line up and get in position where the waves are building and getting ready to break.
From there when you spot the right one you paddle as fast as you can and when you feel the energy of the wave start propellign you forward you stand up and enjoy the surf. Let it take you for a ride.
But the point is that you surf with the wave, not against it.
The idea behind the Commitment of Traders report is the same.
Surf with the smart money, and not against it. Follow the professionals, not the emotional retail crowd.
How to Read the Commitment of Traders Report
First we start by pulling up the information about the SP500 futures positions in the past week. I use Tradinster.com
for these charts as they lay them out a lot cleaner than the source data at the CFTC.
The chart below shows you the position changes across different categories on the left side.
Let’s review what each one means.
- Dealer Intermediary Category
– this is a representation of neutral volume. It is institutions making contracts for their clients, and does not represent biased volume. For this reason, we mostly ignore the first category.
- Asset Manager / Institutional
– this represents volume from institutional money and is very important. These are pension fund managers, mutual funds, and professionally managed assets. You can accept this volume as the professional money that is longer term biased with a bullish view.
- Leveraged Funds
– these are positions by hedge funds, and speculative traders. This category is more volatile and has shorter term biases and trading horizons.
The last two categories are not important and we can skip them altogether.
How to Use the Commitment of Traders Report to Build a Trading Bias
One of the most important pieces of information this report provides is the ability to track the flow of money into and out of assets between the money management side and the hedge funds. These are categories 2 and 3 from above.
Let’s look at the same chart again and do some analysis.
Asset Managers / Institutional:
The first observation is that this class of money has 1.4M contracts in total on the long side. They have just 755k contracts on the short side as a safety or hedge. This is a 2:1 ratio, and indicates an overall bullish sentiment.
But more importantly, this past week you can see that the asset managers added 123,000 new contracts to the long side of the trade, versus just 18,720 to the short side. The money has flowed into the long side on a net basis.
Another way to say this is that the institutional money bought the dip of the previous week and increased their long.
The information is enough to tell us that the smart money is piling into the long side and still confident the trend will continue in the coming few weeks.
But what about the hedge funds, what did they do?
The Leveraged Fund category shows that hedge funds pulled out nearly 200k contracts from the long side, reducing their bullish exposure. At the same time, they also removed 100k contracts from the short side also, reducing their exposure on the downside almost as aggressively.
What does it mean when a trader closes a position and gets out?
They receive cash in return.
The more cash on the sidelines, the more purchasing power that is sitting on the sidelines.
Another scenario is that this money was invested in another asset class.
To confirm this scenario you would pull up another asset from the Commitment of Traders Report, like bonds, gold, US dollar, etc.
Commitment of Traders Report Conclusion – Follow the Money
The goal of using this report is to follow the smart money and find where money is from from and to. If you look at this report long enough you’ll start to notice concrete patterns.
It is very useful to understand the basics of modern portfolio management and the institutional rotation between asset classes.
Using this report is not exact science, or the holy grail.
It is another useful tool to include in your weekly analysis and preparation for the upcoming week.
In all of our TRADEPRO subscriptions, we conduct this analysis in depth every Sunday at 8PM EST.
But I want to teach you how to use this tool more precisely.
We are hosting a FREE webinar this Wednesday July 5th at 7PM EST and we’ll cover the entire report in detail and how to apply it to your trading with more detail.
The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.