Using COT to follow the smart money

The most important factor about large speculative funds is that they tend to be trend followers and aggressors in moving markets. Commercial traders tend to be the shock absorber on the other side of the speculative trade. Commercials tend to be value buyers.
The Commitments of Traders (COT) report from the Commodity Futures Trading Commission (CFTC) provides a window into the market activity of both sides of the market.

If we want to predict future pricing behavior using COT data, we should analyze longer-term trends in speculative money capital flows. Most of the time, the money flow of the speculative capital will turn either up or down in advance of major trend changes in the price of the underlying commodity.

This market action is good because it gives investors and commercials time to make a smart decision on what actions to take. Sometimes, it will occur after a change in trend already has occurred, but normally this later signal still will provide ample time to make a smart hedging or investment decision. No one indicator can be right 100% of the time. This money flow technique also should be used with other technical and fundamental indicators to improve overall success.

Some of those factors include the following:

  • Relative price of the underlying commodity in relation to the Continuous Commodity Index (CCI);
  • Current level of the money flow in relation to historical precedent (that is, whether we are at extreme low levels or high levels that have been associated with major trend changes in the past);
  • Price momentum indicators, such as different crosses of moving averages at different durations;
  • Relative price value as a standard deviation from the 200-day moving average; and
  • Major recent structural supply/demand changes.

Here we’ll discuss a methodical approach to how to use the COT data to provide high probability price outcomes so that investors and commercial operators can make the best buy and sell decisions. We’ll examine this approach in the context of the crude oil market and go over a five-year analysis of how this system works, and what the current setup portends for current price direction.

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