Commitment of Traders (COT): Key Commodity Sentiment Measure

Some investors and analysts within the commodity trading world believe that commodity markets are influenced by market sentiment to a lesser degree than the stock market or other financial markets. However, past research indicates that commodity markets have a substantial sentiment element. As such, using market sentiment indicators is as critical for commodity traders as researching a specific commodity’s supply and demand levels. Earlier, I touched upon the importance of using social media sentiment for commodity investment analysis. In this article, I’ll cover a major commodity market sentiment measure – the Commitment of Traders (COT) report.

What is COT?

The Commitment of Traders (COT) report is a weekly publication released by the US Commodity Futures Trading Commission (CFTC). It provides a breakdown of the positions held by different categories of traders in various commodity futures contracts. The COT report segments traders into three main categories:

a. Commercial Hedgers. These are entities that use futures contracts to hedge their positions in the underlying commodity. Commercial hedgers are typically commodity producers, importers, and other players along the physical commodity supply chain. They take positions in the market primarily to protect themselves from price fluctuations.

Besides the key actors along commodity supply chains, the commercial hedgers group might also include other large entities, e.g., some banks or investment funds, whose primary goal is minimizing the effect of price fluctuations.

b. Large Speculators. These are institutional or individual traders who engage in futures trading for speculative purposes and have large-scale position commitments. They often seek profit from short- to medium-term price movements. A typical large speculator would be a major hedge fund actively investing in commodities.

c. Small Speculators. Individual traders, often retail investors, fall into this category. They typically have smaller positions compared to commercial hedgers and large speculators.

The COT report provides data on the net long or short positions of each category, giving traders valuable insights into the overall market sentiment. The report is released every Friday, outlining the three groups’ futures positions as of Tuesday of the same week.

How to Interpret COT

Interpreting the COT report requires understanding the relationship between the positions of different trader categories and price movements. Some key points to consider are:

a. Commercial Hedgers. When commercial hedgers hold net-long positions, it indicates their confidence in rising prices. Conversely, net-short positions suggest a bearish outlook. Since hedgers are often directly involved in the physical market, their positions can be seen as a reflection of actual supply and demand conditions.

b. Large Speculators. The positions of large speculators are often considered a contrarian indicator. When they are excessively net-long, it may signal a potential market top, and when they are heavily net-short, it may indicate a market bottom.

c. Small Speculators. Small speculators are typically considered trend followers, and their positions may align with the overall market trend. However, extreme positions by small speculators may indicate a crowded trade, potentially leading to a reversal.

Suitability of COT by Specific Commodity

The COT report is more suitable as a sentiment measure for actively traded commodities. Commodities with significant futures trading activity and diverse market participants are the best candidates to analyze using COT. Examples include gold, crude oil, or soybeans. In these markets, the COT data can provide meaningful insights into the sentiment of various players.

For thinly traded commodities or those dominated by a few players, the COT report may not be as informative. In such cases, changes in positions by a single large trader or a few participants can skew the overall sentiment interpretation.

Pros of COT

The COT report offers several advantages for traders and investors:

a. Transparency. It offers transparency into the actions of different trader categories, promoting a better understanding of market dynamics.

b. Contrarian Indicators. The report's contrarian indicators, primarily derived from the positions of the large speculators group, allow traders to potentially identify turning points in the market.

c. Confirmation Tool. COT data can act as a useful confirmation tool, validating other technical or fundamental analyses.

d. Learning Tool for Beginner Traders. COT might be a useful tool for beginner commodity traders to study the positions and moves of the market’s big players.

Cons of COT

While the COT report is a valuable sentiment measure, it does have some limitations:

a. Delayed Data. The COT report provides data with a 3-day lag, making it less useful for intraday or short-term trading strategies.

b. No Real-Time Data. The report is released once a week, on Fridays, and isn’t able to catch the changing dynamics of commodity markets in real time. Given how volatile many commodity segments can be, this is a major drawback of COT.

c. Errors in Data. You might have thought that a CFTC-reported important weekly publication would contain only accurate data. Unfortunately, that’s not always the case. Errors in the published positions do sneak into COT from time to time. These researchers even went as far as to call the data in COT “riddled with errors”.

d. Superfluous Nature. Some analysts are of the opinion that the COT report gives only a superfluous, and thus potentially biased, view of market dynamics. The report simply indicates the positions taken by market participants, without providing insight into the underlying factors behind these positions.

COT is probably the leading market sentiment measure for commodity traders. It’s highly useful as part of an overall market assessment exercise. However, it is of limited use as a standalone measure and suffers from certain limitations that might lead to biased or outright erroneous conclusions. I highly recommend that sentiment assessments for any commodity segment or asset include both the COT report and social media sentiment measures.