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Commitment of Traders,
what's all the hype?

All I've been hearing lately is Commitment of Traders, Commitment of Traders, Commitment of Traders, also known as the COT; like this is some new magic bullet or something.   Let me just say, I'm not impressed.

What is the COT?

What is the Commitment of Traders anyway, and why has it been getting so much attention lately?

Well, some of those big-time guru traders have been hyping their new books and trading strategies on how to use the commitment of traders; therefore everyone has been hearing how great this "new" indicator is.  Well, I'm here to tell you it's NOT new, (First published in 1962...if it's older than me, I don't consider it new.) and, in my humble opinion, it's NOT much better than picking between red and black in Las Vegas, when trying to help predict market direction.

The commitment of traders is a report put out by the CFTC on a weekly basis.  http://www.cftc.gov/cftc/cftccotreports.htm.

The COT outlines three basic groups of traders.

1. The Commercials (Large industrial organizations.)

2. The Non-Commercials (Financial institutions, commodity & hedge funds plus large speculators.)

3. The Non-Reportable. (Small speculators...like me.)

Everyone knows that the Commercials are the major players in this game, and they are the true "Market Makers".

The Basic Trading Concept:

The basic concept for most traders using the COT as a market indicator say to themselves "Wow, the commercials are all shorting the market, I guess I better go short too, the markets must be heading down!"  Sometimes they are dead on, but just as often, they are dead wrong.  About as accurate as red vs. black.

The Real Question:

The question must be asked.  "If the Commitment of Traders simply and accurately tells us when everyone is trading long or short in a market, then why is it not an accurate indicator of market direction?"

Well, I asked the same question to myself a hundred times.  Here at Gecko Software, Inc., we've been working diligently to include the COT in an upcoming release of our software, and so we've been looking into this thing for sometime now.

The Cash Market?

Last week I was sitting at lunch with one of my good friends, who just so happens to own a large "commercial" oil refinery.  As we talked and discussed the inner workings of his refinery, I asked him where he purchased most of his crude?  He mentioned that it primarily came in by rail, and that for the most part, his crude was purchased on the "CASH" market, but on occasion, they would take delivery through purchasing contracts on the NYMEX futures exchange.

Of course, I jumped on this and asked if he had a copy of Gecko-Charts, and if he would like a copy. (Always the salesman I am.)

My Epiphany:

It was not until the drive home that I started contemplating what my friend had just told me.  He purchases most of his crude on the CASH market, then HEDGES it on NYMEX, yet he also takes delivery by purchasing contracts FROM NYMEX. (He may even be hedging UL Gas or Heating Oil, since that's the product he is going to be producing with his crude.)

The question popped into my head, "how would that effect the Commitment Of Traders report?"  And then it all became very clear as to why the commitment of traders was basically useless as a market directional indicator.

The Answer is Clear:

You see, the whole time my friend is purchasing hundreds of thousands of gallons of crude oil on the "cash" market, he is also selling thousands of contracts on the NYMEX.  Of course, the CASH purchases are never reported in the COT report.  Therefore, you think he is selling, selling, selling, and the price of crude must assuredly go down.  But no, he is buying like hell on the cash market, indirectly driving prices up, while "hedging" his long positions from the cash market with his short positions in the futures market, effectively locking in his profit margin.

Here I am, this dinky little speculator out here, scouring over my COT report, seeing these huge corporations selling thousands of contracts.  I get all excited, and start thinking the market must assuredly be headed down, therefore I jump on the bandwagon and join the sweeping sell off of contracts, when in reality, the commercials are buying millions of gallons of crude on the cash market, which in effect, is driving prices back up.

The reversal:

Like any good trader would do, I think to myself, "oh, that's too simple, every time the commercials start selling like mad, then I should go long, because they are really just hedging their cash purchases, thus the market should rally and go up."  Good idea right?

Visa-Versa:

On the production side, you don't know if he is actually purchasing the crude for delivery, HEDGING his cash crude, selling, or hedging his newly refined UL Gas and Heating Oil.

My Research:

In discussing my above mentioned theory about the COT with CFEA (Commodity Futures and Equity Analytics.); Gecko Software's contracted research firm.  The President, Mr. Scott Barrie, confirmed that basically you only see half the equation with the commercial data in the COT, and that seems to be the major problem with the COT report as a market directional indicator.

Conclusion:

Will Gecko-Charts one day have COT data?  Yes it will.  Why?  Because people keep asking for it.  Will I personally use it?  Nope, not anymore often than my dartboard -- I have yet to be convinced that it has much value in helping me predict market directional movement.

Simply put: "You may know their positions, but you don't know their intentions."

Good luck,
Lan H. Turner, CEO
Gecko Software, Inc.

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