Real Wealth Society

Tuesday, January 03, 2006

The history of the Commitments of Traders (COT) report By Wayne N. Krautkramer


Yes, the 10,000 lb. gorilla
counts coup again. The Commitment Of Traders Report is history, as far as its accuracy is concerned. How has this happened, a trader might ask?

"Let’s go to the Videotape",
Warner Wolf would have said!
The history of the Commitments of Traders (COT) report

"The first
Commitments of Traders (COT) report was published for 13 agricultural commodities as of June 30, 1962. At the time, this report was proclaimed as "another step forward in the policy of providing the public with current and basic data on futures market operations." Those original reports were compiled on an end-of-month basis and were published on the 11th or 12th calendar day of the following month."

The purpose of the COT was to differentiate between Commercial and Non-Conmmercial Traders
"Commercial and Non-commercial Traders – When an individual reportable trader is identified to the Commission, the trader is classified either as "commercial" or "non-commercial." All of a trader’s reported futures positions in a commodity are classified as commercial if the trader uses futures contracts in that particular commodity for hedging as defined in the Commission’s regulations (1.3(z)). A trading entity generally gets classified as a "commercial" by filing a statement with the Commission (on CFTC Form 40) that it is commercially "…engaged in business activities hedged by the use of the futures or option markets." In order to ensure that traders are classified with accuracy and consistency, the Commission staff may exercise judgment in re-classifying a trader if it has additional information about the trader’s use of the markets.

A trader may be classified as a commercial in some commodities and as a non-commercial in other commodities. A single trading entity cannot be classified as both a commercial and non-commercial in the same commodity. Nonetheless, a multi-functional organization that has more than one trading entity may have each trading entity classified separately in a commodity. For example, a financial organization trading in financial futures may have a banking entity whose positions are classified as commercial and have a separate money-management entity whose positions are classified as non-commercial. "

The COT gradually became known as a tool that commodity traders checked in an attempt to see the "thinking" of the large speculators, and the commercials. For most observers, it was a
given that the Commercials, and the Large Speculators, are more knowledgeable about the markets than the "small" speculators. This belief was true in the past!

Commitments of Traders –
An Explanation
"The Commitments of Traders charts illustrate the directions in which three different categories of investors believe a given commodity is headed. These three categories (Commercials, Large Speculators and Small Speculators) are based on the following definitions:Commercials (AKA hedgers) are people or companies that deal with actual commodities as part of doing business. They trade in those futures as a hedge against the risks they run in the course of that business. Commercials are exempt from position limits and post smaller margins than speculators.Large Speculators are traders whose trading levels are high enough that they require reporting to the CFTC (Commodity Futures Trading Commission). These trading levels vary from one commodity to another, and often from one year to another.
Small Speculators are the traders remaining after the Commercials and Large Speculators have been subtracted from the total open interests."

Adam Hamilton informs us that "The Commodity Futures Trading Commission releases its Commitments of Traders report once a week, each Friday. It summarizes changes in futures positions in all major commodities by all major players. While tremendously useful, the CoT is so complex that an air of mysticism has sprung up around it."

"Since the raw CoT data is so specialized, not many investors or analysts bother getting into it. Those who do tend to be revered, kind of like high priests privy to some arcane knowledge. And just like with high priests’ decrees in religion, often the CoT data interpretations by gurus usually go unquestioned or uninvestigated by the faithful. In some cases this blind faith in others’ CoT interpretations can lead to problems", says Adam Hamilton.

The New Reality for the COT report Users
According to the folks at, something has changed in the performance of the Large Speculators.

"Though there are no hard and fast rules about the success of each of these divisions, it is generally assumed that the Commercials are the most successful. The large speculators used to be successful as well but in recent years have done poorly as a group. The small investors are often looked at as the example of what not to do in futures trading. "

Naturally you ask, do you have other evidence, or support for your claims that the COT is now impaired as a trading tool? I’m so glad that you asked for more!
John Fenton, the CFTC deputy director of market surveillance acknowledged the issue in a recent interview given to Daniel P. Collins of
Futures (September, 2005).

In the article, Dr. Strangefund: or how I stopped worrying and learned to love the long-only commodity fund, Daniel P. Collins discloses his conversation with the CFTC. John Fenton of the CFTC told Daniel P. Collins, "When a swap dealer comes into the futures market and they are hedging price risk from OTC transactions, they are categorized as commercials"
"What we are evaluating is whether the data we are getting and the way we are getting it would allow us to break it out any other way," Fenton says.
William Plummer of Rangewise, Inc. said "It shows up in the reporting as commercial activity when in reality it’s speculative activity . The actual CFTC reporting in the commercial category is being distorted because some large percentage of that is really speculative trading, and not reflective of commercial activity"

Floyd Upperman, a CTA and an advocate of COT reports, says "There has always been some crosscontamination in the COT reports, between hedgers and speculators." "Although still valuable, COT reports now may need more of a trained eye to read", Upperman notes.

After reviewing the evidence, and the testimony of some of the experts on the use of the COT report, one must conclude that something major is changing in the raw data that the CFTC uses to compile the COT report.
A lot of speculative activity is now being misclassified as commercial activity.
The real question is what does this mean to users of the COT report?
The deputy director of market surveillance for the CFTC has confirmed that there is a problem with the data, and the classification process. The CFTC itself admits that there is a problem, so we can dismiss any counter argument that there is no problem with the COT report.

William Plummer of Rangewise, Inc. has informed us of the extent of the misclassification problem in the COT report.

Adam Hamilton has informed us that COT interpretation was always very difficult due to the massive amount of raw data that must be interpreted.
Floyd Upperman has told us that interpreting the COT reports may now require more of a trained eye!

Remember that the original purpose of the COT reports was to monitor the actions of the real professionals (Commercials)
If the Large Speculators actions are being classified as Commercials, what is the point of reading the report?

We have already been informed by Software North that the Large Speculators have done poorly as a group in recent years. Yeah, that’s who we want to

It appears that a somewhat subjective tool has just become even more subjective! What’s the bad news?

It’s time to invoke the tried and true rule of
Caveat Emptor. As there is no warranty that comes with the use of the COT reports, I would suggest that the trader be very cautious when using the current COT reports.

One might ask what the Commercials, and the professional speculators really use, as they were obviously successful prior to the creation of the COT report in 1962!

The mother lode must lie elsewhere!

Why did you believe that the COT reports were the secret of investing in the first place? It’s a reasonable assumption that "they" told you that big boys used the COT as a decision making tool.

Would "they" lie to you?
Let’s look at the odds!
You ask, Who is the one lying to us?
"That would be telling!"

"The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society."
Edward Bernays
"In addition to his uncle Sigmund
Freud, Bernays also used the theories of Ivan_Pavlov."

Wayne N. Krautkramer

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