The Commitments of Traders (“CoT” or “COT”) report, issued by the securities regulatory body, provides a snapshot of futures positions held by both large and small commercial hedgers and speculators in each major commodity and commodities exchange. The data is broken down into different commodities and trader types, and even the size of the positions [see Top 100 Futures Trading Blogs].

There are three types of traders in each COT report:

• Commercial Traders represent companies that use the futures market to offset risk in the cash or spot markets. For instance, a soybean farmer may want to hedge crop prices in order to ensure that they can sell their product at a set price. Since they are not speculating on price direction, these traders aren’t particularly helpful to watch for traders looking for hints on future direction.

• Non-Commercial Traders are institutional investors and hedge funds that speculate on commodity prices to profit from short-term or long-term movements. For instance, a hedge fund may purchase corn futures to benefit from the impact of new ethanol regulations on corn prices without ever intending to take physical delivery. Since they are speculating on price direction, these are the traders to watch most closely.

• Non-Reporting Traders are smaller individual traders not required to report their positions to the CFTC. Oftentimes, these traders are inexperienced and not always accurate at predicting market trends. As a result, this is a category that should also be ignored by those reading COT reports.

For each of these trader types, the COT report outlines the number of long positions, short positions and spread positions (for commercial traders), as well as changes in these positions over the past month. The data can then be analyzed in order to determine where the money is moving in the industry, particularly among large speculative traders.

Commitments of Traders reports can be found on the Commodity Futures Trading Commission’s website. The most relevant reports can be found in the “Current Legacy Reports” section, which breaks down the trading in various commodities by their exchange.

Individual traders should watch three parts of this report:

1. Non-Commercial Trader distributions provide insight into whether or not institutional investors and hedge funds are predominantly long or short on a given commodity before taking a look at any changes in these numbers compared to the prior month.
2. Changes in Commitments shows whether or not these traders are adjusting their positions to be long- or short-biased during the reported month, which is important when determining if trends are ongoing or reversing over time.
3. Number of Traders in each position can show whether or not these changes were broad-based or simply trades placed by a handful of major players. For instance, a single trader placing a large short trade may not be considered as reliable as many doing the same.

These three elements can provide individual traders with significant insights into futures market trends since they track changes in large institutional commodity portfolios. Given that smaller trades can move in and out of commodities at a greater speed, these reports can provide profitable short-term trading ideas in addition to showing long-term trends.

Reading the data on the Commitments of Traders reports isn’t particularly helpful without some historical context that provides insights into short-term and long-term trends. By inputting the data from the last section into a spreadsheet every month, traders can analyze these trends over time to determine any changes that are taking place and their implications.

Here’s a simple strategy to use COT reports to determine trends:

1. Input at least six months of long and short data for non-commercial traders into a spreadsheet, with columns for the dates, long positions and short positions.
2. Using the data above, generate a line chart showing these trends over time, with the date on the Y-axis and the long and short positions as two lines on the X-axis.
3. Overlay the average prices over the same period for the commodity, using an independent X-axis while aligning the dates, in order to show how these trends have affected price direction over a long period of time.
4. Look for divergences between these two charts – where they are moving in opposite directions – for potential reversal situations. For instance, if the price is falling and traders are increasing going long, look for a potential positive future price trend.
5. Before placing the trade, ensure that the current month’s overall long or short data is moving in the same direction as the potential trade. As the old trading adage goes,, the trend is most often your friend, and betting against it can be risky.

Some traders recommend fading small speculators in the market since they tend to consistently be on the wrong side of the trade. Unfortunately, this strategy doesn’t work all of the time because the non-reportable traders category includes both small speculators and small hedgers, which skew the data and make it almost always unusable for these purposes.

The Commitments of Traders (COT) report provides the public with a glimpse into what the major commercial and institutional traders are doing. Leveraging these insights, individual traders can identify key trends and reversals that could lead to profitable trading ideas.

While the COT report may provide useful information, it’s certainly not a foolproof way to make money in the commodities market. After all, the positions reported are all after the fact, and short-term trends are unreliable. Savvy investors should conduct their own due diligence in addition to using reports like these in order to generate consistently profitable trades.

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Disclosure: No positions at time of writing.