Using COT To Follow
The Smart Money
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.
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
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.
of those factors include the following:
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
price of the underlying commodity in relation
to the Continuous Commodity Index (CCI);
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);
momentum indicators, such as different crosses
of moving averages at different durations;
price value as a standard deviation from the
200-day moving average; and
recent structural supply/demand changes.
first step is to understand the nomenclature shown in
“Big money flows” (below). Remember, we are looking
for term-trend changes, and one of the best time frames
for that is monthly price and COT charts.
reliable indicator for this exercise is moving average
convergence-divergence (MACD), applied here not to price
but to the speculative money flow net positions from
the CFTC’s COT reports at www.cftc.gov. The MACD simply
is a way to use different duration moving averages to
determine trend changes, identified by when the lines
cross each other. The two different moving averages
used for the MACD on “Big money flows” are the 12-month
(blue line) and 24-month (red line) durations. When
they cross to the downside, it is a money flow sell
signal. When they cross to the upside, it is a money
flow buy signal.
look at 2008 when crude oil made a historic high and
review what this methodology would have predicted. As
you can see, a major MACD money flow sell signal was
triggered in May 2008. This sell signal occurred two
months before the final top and before one of the greatest
collapses in crude oil history. The COT/MACD analysis
was an excellent leading indicator that a major top
was approaching and that a significant selling opportunity
had become available to investors and commercials alike.
COT analysis is a reliable trade entry signal, it is
not quite sensitive enough to protect profits. For that,
it’s better to rely on an indicator based on price itself.
There is a reliable trigger to cover a particular position
and take profits after a major MACD money flow sell
signal/buy signal has been initiated. Applied to price,
it’s when the three-month moving average (red line)
and the six-month moving average (blue line) cross.
at the chart, we can see that a bullish crossing of
these moving average lines occurred in April 2009, which
would have directed us to buy back shorts at about $60
per barrel on a short position initiated around $120
per barrel, for a tidy $60 per barrel profit.
signals generated on this chart include:
The current crude oil market provides a good example
for understanding the basis for this approach. The crude
oil market remains in a MACD money flow sell signal,
suggesting that lower prices are likely, especially
given the relatively high level of current speculative
positions as it relates to historical precedent.
MACD money flow buy signal was triggered in
June 2009 at $70 per barrel. Using the same
moving average methodology for the spot price
chart would have gotten us out of the market
in July 2010 at about $75 per barrel for a small
$5 per barrel profit.
MACD money flow buy signal was triggered November
2010 at $85 per barrel. A spot price moving
average sell signal was triggered at $95 per
barrel for a modest $10 per barrel profit.
September 2011, a MACD money flow sell signal
was triggered at about $80 per barrel, which
was followed by a surprise rally. The price
indicator got us out of the market in December
2011 at $95 per barrel for a $15 loss.
is a shame that a spot price moving average buy signal
was triggered that caused a buy-back and a loss. All
traders know that sometimes markets just act in strange
and unexpected fashions. We likely are in a scenario
where crude oil is heading lower, and perhaps a renewed
spot price moving average sell signal will be the catalyst
to re-establish prior short positions.
key to making money in commodities is not to lose a
lot while you are seeking the occasional big score,
such as what was made in 2008 in the crude oil market.
No one can predict the next big trade, other than to
say that it will come. Successful traders put themselves
in position to take advantage of those trades when such
an asymmetrical opportunity arises. This is true for
all markets, not just energy, and this COT-based approach
works equally well in all other commodity markets, particularly
the agricultural markets.
now, most commodity markets have well-established MACD
money flow sell signals and there is not yet any sign
that a major turn-up in speculative money flows is imminent.
However, many markets are beginning to see extreme low
levels of money flows that have preceded major turns
back up in overall pricing behavior. Based on this,
the next three to six months should provide major buying
opportunities as evidence begins to mount that speculative
capital flows have begun to move back in. This should
set off a series of MACD money flow buy signals that
investors and commercials can use to position for the
potential next big bullish trending opportunity. We
also should get a series of spot price moving average
buy signals that should trigger us to close out prior
now, the bears remain in control, but the bulls should
begin to wake up and smell the next major price rise.
The key will be to follow closely speculative capital
flows, and the system described here has been one of
the better ways to profit from the long-term changes
on COT trends.
most important quality for making consistent money using
the COT data and this simple system is to remain patient
and wait for the sell/buy signals. It is all too tempting
to try and jump the gun and attempt to front-run a major
money flow signal. That is where many COT data followers
is better to miss some of the upside from a major low
and know for sure a money flow trend has turned up than
to try and speculate that it will. All too often you
will find yourself trying to catch a falling knife that
keeps falling further than estimated when there’s a
delay in money flow’s eventual return.
are entering a dynamic time in overall commodities.
There is a high likelihood that 2012 will be viewed
in hindsight as the year of major lows, providing hugely
profitable buying opportunities. More time is required
to find evidence that speculative capital flows have
begun to come back into overall commodities. With respect
to crude oil, the path of least resistance is for much
lower prices given the current MACD sell signal and
historically high current level of money flow. With
crude oil expensive in relation to the CCI as well,
all arrows are pointing down. Look for a spot price
moving average sell signal to trigger getting short
used correctly, and with discipline, the COT data can
be a treasure chest of valuable timing signals for more
reliable profits over time.