Using COT Report To Forecast FX Movements

July 20, 2005 | y !at"y #ien, C"ie$ %trategist, FXCM
et&een 200' an( 200), volume in t"e $oreign*e+c"ange mar,et increase( more t"an 50-, illustrating
t"e overall rise in popularity o$ currency tra(ing. T"e a(vent o$ online tra(ing $ollo&ing t"e tec"nology
/oom "as allo&e( many e0uity an( $utures tra(ers to loo, /eyon( t"eir more tra(itional tra(ing
instruments. Most s"ort*term tra(ers or speculators tra(e FX /ase( on tec"nical analysis, so e0uity an(
$utures tra(ers &"o use tec"nical analysis "ave ma(e t"e s&itc" to FX $airly easily. 1o&ever, one type
o$ analysis t"at tra(ers "ave not /een a/le to trans$er over to currencies is volume*/ase( tra(ing. %ince
t"e currency mar,et is (ecentrali2e( an( t"ere is no one e+c"ange t"at trac,s all tra(ing activities, it is
(i$$icult to 0uanti$y volume tra(e( at eac" price level. ut in place o$ volume*/ase( tra(ing, many
tra(ers "ave turne( to t"e Commo(ity Futures Tra(ing Commission3s Commitments o$ Tra(ers 4COT5
report, &"ic" (etails positioning on t"e $utures mar,et, $or more in$ormation on positioning an(
volume. 1ere &e loo, at "o& "istorical tren(s o$ t"e COT report can "elp FX tra(ers.
What is the COT Report?
T"e Commitments o$ Tra(ers report &as $irst pu/lis"e( /y t"e CFTC $or '6 agricultural
commo(ities in '782 to in$orm t"e pu/lic a/out t"e current con(itions in $utures mar,et operations
4you can $in( t"e report on t"e CFTC &e/site "ere5. T"e (ata &as originally release( 9ust once a mont",
/ut move( to once every &ee, /y 2000. :long &it" reporting more o$ten, t"e COT report "as /ecome
more e+tensive an( * luc,ily $or FX tra(ers * it "as no& e+pan(e( to inclu(e in$ormation on $oreign
currency $utures. ;$ use( &isely, t"e COT (ata can /e a pretty strong gauge o$ price action. T"e caveat
"ere is t"at e+amining t"e (ata can /e tric,y, an( t"e (ata release is (elaye( as t"e num/ers are
pu/lis"e( every Fri(ay $or t"e previous Tues(ay3s contracts, so t"e in$ormation comes out t"ree
/usiness (ays a$ter t"e actual transactions ta,e place.
Reading the COT Report
Figure ' is a sample euro FX &ee,ly COT report $or June <, 2005, pu/lis"e( /y t"e CFTC. 1ere is a
0uic, list o$ some o$ t"e items appearing in t"e report an( &"at t"ey mean=
• Commercial * (escri/es an entity involve( in t"e pro(uction, processing, or merc"an(ising o$ a
commo(ity, using $utures contracts primarily $or "e(ging.
• Long report * inclu(es all o$ t"e in$ormation on t"e 3s"ort report3, along &it" t"e concentration
o$ positions "el( /y t"e largest tra(ers.
• Open interest * t"e total num/er o$ $utures or options contracts not yet o$$set /y a transaction,
/y (elivery or e+ercise .
• Noncommercial (speculators) * tra(ers, suc" as in(ivi(ual tra(ers, "e(ge $un(s > large
institutions, &"o use $utures mar,et $or speculative purposes an( meet t"e reporta/le
re0uirements set $ort" /y t"e CFTC.
• Non-reportable positions * long > s"ort open*interest positions t"at (on3t meet reporta/le
re0uirements set $ort" /y t"e CFTC.
• Number of traders * total num/er o$ tra(ers &"o are re0uire( to report positions to t"e CFTC.
• Reportable positions * t"e $utures an( option positions t"at are "el( a/ove speci$ic reporting
levels set /y CFTC regulations.
• Short Report * s"o&s open interest separately /y reporta/le > non*reporta/le positions.
• Spreading * measures t"e e+tent to &"ic" a non*commercial tra(er "ol(s e0ual long an( s"ort
$utures positions.

Figure '
Ta,ing a loo, at t"e sample report, &e see t"at open interest on Tues(ay June <, 2005, &as '76,<0<
contracts, an increase o$ 6,2'6 contracts $rom t"e previous &ee,. ?oncommercial tra(ers or speculators
&ere long 22,767 contracts an( s"ort )0,<'0 contracts * ma,ing t"em net s"ort. Commercial tra(ers, on
t"e ot"er "an(, &ere net long, &it" '7,768 more long contracts t"an s"ort contracts 4'25,2)) *
'05,60@5. T"e c"ange in open interest &as primarily cause( /y an increase in commercial positions as
noncommercials or speculators re(uce( t"eir net*s"ort positions.
Using the COT Report
;n using t"e COT report, commercial positioning is less relevant t"an noncommercial positioning
/ecause t"e ma9ority o$ commercial currency tra(ing is (one in t"e spot currency mar,et, so any
commercial $utures positions are "ig"ly unli,ely to give an accurate representation o$ real mar,et
positioning. ?oncommercial (ata, on t"e ot"er "an(, is more relia/le as it captures tra(ers3 positions in
a speci$ic mar,et. T"ere are t"ree primary premises on &"ic" to /ase tra(ing &it" t"e COT (ata=
• Flips in mar,et positioning may /e accurate tren(ing in(icators.
• A+treme positioning in t"e currency $utures mar,et "as "istorically /een accurate in i(enti$ying
important mar,et reversals.
• C"anges in open interest can /e use( to (etermine strengt" o$ tren(.
Flips in Market Positioning
e$ore loo,ing at t"e c"art s"o&n in Figure 2, &e s"oul( mention t"at in t"e $utures mar,et all $oreign
currency e+c"ange $utures use t"e U.%. (ollar as t"e /ase currency. For Figure 2, t"is means t"at net*
s"ort open interest in t"e $utures mar,et $or %&iss $rancs 4C1F5 s"o&s /ullis" sentiment $or U%BCC1F.
;n ot"er &or(s, t"e $utures mar,et $or C1F represents $utures $or C1FCU%B, on &"ic" long an( s"ort
positions &ill /e t"e e+act opposite o$ long an( s"ort positions on U%BCC1F. For t"is reason, t"e a+is
on t"e le$t s"o&s negative num/ers a/ove t"e center line an( positive num/ers /elo&.
T"e c"art /elo& s"o&s t"at tren(s o$ noncommercial $utures tra(ers ten( to $ollo& t"e tren(s very &ell
$or C1F. ;n $act, a stu(y /y t"e Fe(eral Reserve s"o&s t"at using open interest in C1F $utures &ill
allo& t"e tra(er to correctly guess t"e (irection o$ U%BCC1F <6- o$ t"e time.

Figure 2 * C"art s"o&ing net positions o$ noncommercial tra(ers in t"e $utures $or %&iss $rancs
4correspon(ing a+is is on t"e le$t*"an( si(e5 on t"e ;nternational Monetary Mar,et 4;MM5 an( price
action o$ U%BCC1F $rom :pr 2006 to May 2005 4correspon(ing a+is is on t"e rig"t*"an( si(e5. Aac"
/ar represents one &ee,. %ource= Baily FX.
Flips * &"ere net noncommercial open*interest positions cross t"e 2ero line * o$$er a particularly goo(
&ay to use COT (ata $or %&iss $utures. !eeping important notation conventions in min( 4t"at is,
,no&ing &"ic" currency in a pair is t"e /ase currency5, &e see t"at &"en net $utures positions $lip
a/ove t"e line, price action ten(s to clim/ an( vice versa.
;n Figure 2, &e see t"at noncommercial tra(ers $lip $rom net long to net s"ort %&iss $rancs 4an( long
(ollars5 in June 2006, coinci(ing &it" a /rea, "ig"er in U%BCC1F. T"e ne+t $lip occurs in %ept 2006,
&"en noncommercial tra(ers /ecome net long once again. Using only t"is (ata, &e coul( "ave
potentially tra(e( a <00*pip gain in $our mont"s 4t"e /uy at '.6' an( t"e sell at '.6@5. On t"e c"art &e
continue to see various /uy an( sell signals, represente( /y points at &"ic" green 4/uy5 an( re( 4sell5
arro&s cross t"e price line.
Aven t"oug" t"is strategy o$ relying on $lips clearly &or,s &ell $or U%BCC1F, t"e $lip may not /e a
per$ect in(icator $or all currency pairs. Aac" currency pair "as (i$$erent c"aracteristics, especially t"e
"ig"*yiel(ing ones, &"ic" rarely see $lips since most positioning ten(s to /e net long $or e+ten(e(
perio(s as speculators ta,e interest*earning positions.
Extreme Positioning
A+treme positioning in t"e currency $utures mar,et "as "istorically also /een accurate in i(enti$ying
important mar,et reversals. :s in(icate( in Figure 6 /elo&, a/normally large positions in $utures $or
DECU%B /y noncommercial tra(ers "as coinci(e( &it" tops in price action. 4;n t"is e+ample, t"e le$t
a+is o$ t"e c"art is reverse( compare( to Figure 2 /ecause t"e DE is t"e /ase currency.5 T"e reason
&"y t"ese e+treme positions are applica/le is t"at t"ey are points at &"ic" t"ere are so many
speculators &eig"te( in one (irection t"at t"ere is no one le$t to /uy or sell. ;n t"e cases o$ e+treme
positions illustrate( /y Figure 6, every one &"o &ants to /e long is alrea(y long. :s a result,
e+"austion ensues an( prices /egin reversing.

Figure 6 * C"art s"o&ing net noncommercial positions in DE $utures on ;MM 4correspon(ing a+is is
on t"e le$t*"an( si(e5 an( price action o$ DECU%B 4correspon(ing a+is is on t"e rig"t*"an( si(e5 $rom
May 200) to :pr 2005. Aac" /ar represents one &ee,. %ource= Baily FX.
Changes in Open Interest
Open interest is a secon(ary tra(ing tool t"at can /e use( to un(erstan( t"e price /e"avior o$ a
particular mar,et. T"e (ata is most use$ul $or position tra(ers an( investors as t"ey try to capitali2e on a
longer*term tren(. Open interest can /asically /e use( to gauge t"e overall "ealt" o$ a speci$ic $utures
mar,etF t"at is, rising an( $alling open interest levels "elp to measure t"e strengt" or &ea,ness o$ a
particular price tren(.
For e+ample, i$ a mar,et "as /een in a long*lasting uptren( or (o&ntren( &it" increasing levels o$ open
interest, a leveling o$$ or (ecrease in open interest can /e a re( $lag, signaling t"at t"e tren( may /e
nearing its en(. Rising open interest generally in(icates t"at t"e strengt" o$ t"e tren( is increasing
/ecause ne& money or aggressive /uyers are entering into t"e mar,et. Beclining open interest in(icates
t"at money is leaving t"e mar,et an( t"at t"e recent tren( is running out o$ momentum. Tren(s
accompanie( /y (eclining open interest an( volume /ecome suspect. Rising prices an( $alling open
interest signals t"e recent tren( may /e nearing its en( as $e&er tra(ers are participating in t"e rally.
T"e c"art in Figure ) (isplays open interest in t"e AURCU%B an( price action. ?otice t"at mar,et
tren(s ten( to /e con$irme( &"en total open interest is on t"e rise. ;n early May 200), &e see t"at price
action starts moving "ig"er, an( overall open interest is also on t"e rise. 1o&ever, once open interest
(ippe( in a later &ee,, &e sa& t"e rally toppe( out. T"e same sort o$ scenario &as seen in late ?ov an(
early Bec 200), &"en t"e AURCU%B rallie( signi$icantly on rising open interest, /ut once open interest
levele( o$$ an( t"en $ell, t"e AURCU%B /egan to sell o$$.

Figure ) * Open interest in t"e AURCU%B 4correspon(ing a+is is on t"e le$t*"an( si(e5 an( price action
4correspon(ing a+is on rig"t*"an( si(e5 $rom Jan 200) to May 2005. Aac" /ar represents one &ee,.
%ource= Baily FX.
Summar
One o$ t"e (ra&/ac,s o$ t"e FX spot mar,et is t"e lac, o$ volume (ata, /ut to compensate $or t"is,
many tra(ers "ave turne( to t"e $utures mar,et to gauge positioning. Avery &ee,, t"e CFTC pu/lis"es a
Commitment o$ Tra(ers report, (etailing commercial an( non*commercial positioning. ase( upon
empirical analysis, t"ere are t"ree (i$$erent &ays t"at $utures positioning can /e use( to $orecast price
tren(s in t"e $oreign*e+c"ange spot mar,et= $lips in positioning, e+treme levels an( c"anges in open
interest. ;t is important to ,eep in min(, "o&ever, t"at tec"ni0ues using t"ese premises &or, /etter $or
some currencies t"an ot"ers.
y !at"y #ien, C"ie$ %trategist, FXCM

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