The Commitments of Traders (COT) reports show futures traders' positions. The report is prepared weekly by the Commodity Futures Trading Commission (CFTC), a U.S. government body with the task of overseeing futures markets.
The report's goal is to create transparency and fight market manipulation. The essence of COT analysis is to subtract the shorts from the longs and arrive to the net commitment of each trader category.
If they hold more long contracts than short contracts, it is clear that they are bullish. Of course, if they hold more shorts than longs, they are bearish.
The 3 categories of participants are Commercial, Large speculators and Small speculators.
The commercials are the product producers, eg. miners, farmers, commodity producers, central banks, banks, institutions. They issue contracts as a hedge on future risk (insurance against a bad month/year).
Large speculators buy contracts from the commercials on speculation that the contract will increase in value over time, these are the guys retail traders want to consider following. Large speculators are trading firms or individuals but also might be the trading arm of banks and institutions looking to capitalise on short term market cycles. They spend a lot of money on analysis and expertise trying to predict the future.
Small speculators tend to match large speculator's positions but are more flexible and responsive short term. It can take months for a large speculator to unwind a position and go from long to short for example.
Looking at the Australian dollar futures chart below large speculators (green) have been net short and increasingly so since June though levelling off and decreasing in September. This positioning has paid off as the Australian dollar trended downward but is now tracking sideways and large speculators are exiting their shorts. Small speculators exited their shorts completely end of June then again mid July (large speculators held on) and decreasing their short positions recently. AUD currently ranging after a downtrend, if large speculators start to go net long might indicate the start of a uptrend.
