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Commitment of Traders Plug-in

Overview

Video Transcript

In this video, we're going to explore one of my favorite secret weapons of trading, the COT, or the Commitment of Traders.

So, what is the Commitment of Traders?

The Commitment of Trader's is a US Federal Government report that informs us what everyone else is trading. Can you imagine? What if you knew what and when all the big banks, hedge fund managers, farmers, and factories were buying and selling? Do you think that could help you be a better trader?

The Commitment of Traders, or COT, is broken down into three categories. First, is what we call the commercials, these numbers represent the farmers, or producers, and the consumers, in this case the wholesalers, and the factories.

Technically speaking, this is the group of traders that the commodities exchanges were primarily created for.

The second and third groups are the speculators, the large specs, such as banks and hedge funds, and the small speculators, and if you're listening to this video, I'm going to assume that's guys like you and me, the little guys.

Prior to the establishment of central exchanges, farmers and/or producers and wholesalers and factory representatives would meet in regional locations to barter for the goods they produced and needed.

As you can imagine, these central locations were chaotic, and often times difficult to manage and arrange a fair deal for both sides.

One such story goes that a butcher went to the central bartering place to pick up a couple piglets, once a fair price had been negotiated, the pig farmer went into the back stall to put the piglets into a gunny sack for transport. Once the butcher, having traveled some distance, finally arrived home, he opened the gunny sack, but rather than piglets jumping out, he set free several wild cats, so it's said, this is where the term, “Who let the cat out of the bag,” came from.

Additionally, in high yield crop years, consumers, or factories could negotiate extremely low prices, and take advantage of the farmers and producers. In years where crops were scarce, the farmers could take advantage of the factories and consumers. This caused both sides a lot of undue stress, due to the seemingly unfair practices of the opposing party, this also, as you can imagine, caused wild price swings.

Central exchanges were not only established as a convenient location to barter, but also as protection for buyer and seller, the exchange itself would guarantee that both parties were compensated for correct price, quantity and quality of goods exchanged.

Plus, the exchange introduced an essential key component that was able to finally bring stability to the market place, that being the speculator.

The speculator is the grease that keeps the entire exchange running smoothly. The speculator was introduced for the sole purpose of helping the farmers, factories, producers and consumers offset their risk liability.

For example, now, at the drop of a hat, a farmer can sell his crop to a speculator, whenever he wants, and doesn't have to wait until harvest, when prices are inevitably at their lowest levels.

All three trading groups, commercial traders, as well as large and small speculators, open their trading accounts through a firm known as an IB, or Introducing Broker, we don't actually open our trading accounts directly with the exchange itself, the brokerage firm is our representative to the exchange.

This allows everyone involved to work from a level playing field, where everyone adheres to the same exact rules and regulations, whether you're a large farmer, a bank or hedge fund, a factory, or a small speculator.

Opening a trading account with an IB is similar to opening a bank savings account, your money is never at risk until you actually buy or sell something.

When placing a trade, we only have to post a small performance bond, called margin, which allows us to control a very large amount of product, with a very small amount of money. It's this leverage that makes being a speculator of commodities so attractive.

If you're not familiar with how margin accounts work, visit our website at: www.TradeMentors.com for more details, but basically, it's like putting a TV you found on special, at your favorite department store, on layaway; you only have to put down a small amount of money to hold the TV at that price.

Now that you've put your TV on layaway, you now have the right to go sell your TV to someone else for a higher price, collect the money from them, and then go pick up the TV and make delivery, and you get to keep the profit. This is basically the same concept when trading futures. Buy low, sell high.

Our recommended brokerage firm is Gecko Financial Services; you can find them on the web at: www.GeckoFS.com

In the current high-tech environment, a farmer can now sell his crop with a simple click of the mouse, without the need to negotiate with any factory or consumer, and conversely, the factory owner can simply click his mouse, and buy the commodities he needs as well.

This is what allows each party, the farmer or the factory owner, to create a budget, get bank loans, buy equipment, and put food on the table for their families, and the best part of all, the farmer doesn't have to actually deliver the commodity until harvest time in the fall, and the factory owner doesn't have to wait until fall to find out his price, he can forward contract with the exchange, and this is why we call it the “futures,” market, we make or take delivery, sometime in the “future,” again, a time specified and guaranteed by the exchange.

In-turn, the speculator, for their services of taking on this risk of loss, as prices increase and decrease, is given the opportunity to possibly gain a large financial reward, which is all calculated and worked into the price of the commodity, which actually makes for a more stable market place for everyone involved.

Now, by having a regulated central exchange, where producers, consumers, and speculators all meet together and each party is guaranteed quality, quantity, and payment, the wheels of commerce can quickly begin to move forward.

As a reflection of all this centralized trading activity, the exchanges began keeping track of what and how much each group of buyers and sellers were actively trading, and they began publishing these results to the public in a report they call the COT, or Commitment of Traders.

Let's take a closer look at the exchanges COT Report, and see how we can use it to help us make money.

Track 'n Trade, our preferred software trading platform, has taken the COT report, and turned it into a technical indicator, and integrated it directly into the price charts themselves.

First, we must put the COT indicator in its place, is it technical, or fundamental?

The information used to create the indicator is the actual buying and selling activity of each individual group of traders, therefore it's classified as fundamental information, but the COT indicator itself is a technical indicator, so it's a highbred of sorts, crossing the boundary of technical indicator and fundamental indicator.

We've taken the fundamental information, and turned it into a technical indicator, which is what makes it, so unique and different from almost all other indicators.

Now, we need to remember that the COT indicator also has advantages and disadvantages.

The advantages are that it tells us when a particular market is truly in play, and when the big money is actually moving into one direction or the other.

The disadvantage of the COT is that this information is only released once per week, each Friday, after markets close, and represents that week's trading activity.

For this reason, we only use the COT to help us establish long-term trend movement over the daily chart time frame; the exchange does not actually give us access to the daily COT data until the end of the week.

That said; let's take a look at how we break down the COT.

In this snapshot, you can see that the Commitment of Traders is broken down into three categories.

Red represents the large commercial traders, this includes both factories as well as farmers, and they actually put both of these groups into one category.

Blue represents the large speculators, like banks and hedge funds.

Green represents small speculators, and if you're watching this video, I'm going to assume that's you.

We also find in the software yellow, which represents total Open Interest, and whether total interest in the specified commodity is increasing or decreasing.

We also have the ability to include options trading activity into the COT as well. This is a personal preference, and changes the numbers somewhat, but is beyond the scope of this video. Suffice it to say, I generally do not include options data when using the COT for standard trend trading purposes, since there's a lot of buying and selling of options for other purposes than simple trend trading.

We also have the ability to run a moving average cross over trend system over the top of the COT indicator, which can also help us identify which direction the big money is moving.

Let's take a look at what a COT indicator looks like when it just represents the Large Commercials:

[Large Commercials]

Here's what the COT looks like when it just represents the Large Speculators:

[Large Speculators]

And here's what it looks like when it just represents the Small Speculators

Now here's what it looks like with all three represented at the same time.

Notice anything funny?

Take a look at the trend of the market. In this chart it's obviously in an uptrend, yet the large commercials, the farmers and the factories, represented by red, are all pointing down, while the large speculators, banks and hedge funds, represented by blue, are all pointing up, and the small speculators, represented in green, are pointing down as well.

So how do we read this, and what does it mean?

Well, that's the million dollar question right?

Many trader's will use and interpret this information in many different ways, but one of the key components you want to remember, is that the Commercials, the farmers and factories are both buying and selling into the market, plus, they're often times hedging against the cash market. Yet, all this buying and selling is represented as the same group, the red large commercials.

As a group to follow, which might help us identify our directional bias, I simply don't trust the commercials, because we never know their true intent, we don't know why their actually buying, or selling, but we do notice, that most of the time, they are doing just the opposite of what we want to do.

We, as small speculators, always want to buy low and sell high, and make money from the increase in price, yet the commercials are all represented here as short selling the market, all the way up an obvious uptrend.

Why would they do that? Wouldn't that cause them to lose money?

Think about it, are they actually short selling the market?

Let's just for a minute, take the farmer's point of view, the farmer is continually selling off some of his crop, taking advantage of rising prices. For him, he's already long the commodity, he has it in his storage bin, or in his field, he needs to sell it to make a profit, so maybe he's actually making more and more money with each sell as prices increase.

That's just one example, I'm sure you can think of several more.

So how do we as small speculators use the COT if we don't trust the large commercials? First of all, we certainly don't want to watch what the other small speculators are doing either, most of them are wrong, so the key here is that we want to watch, and follow, the large speculators, the banks and hedge funds…think about their motives, they're exactly the same as ours, buy low, sell high, make money.

Large banks and hedge funds usually have huge research and development departments, mathematicians watching the technical indicators, they have weather men watching the weather reports, and they have researchers watching the government reports, and the current news as it comes across the wire ahead of broadcast.

You see, these are the guys I like to watch, and I like to follow their lead. I use them as an indication of whether the big money, as I like to call it, is moving in the direction of the overall predicted trend.

If I see the large speculators, starting to push their money into the market one direction or the other, then that's exactly what I want to be doing too.

Now I want to mention quickly, this video is by no means a complete education on all the factors that go into any of the tools mentioned, and is not meant as a complete course on how to use the COT.

This video is only to give an introduction, in an effort to encourage you to continue seeking additional education on this subject.


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