Sentiment in the Forex Market: Indicators and Strategies to Profit from Crowd Behavior and Market Extremes

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88 SENTIMENT IN THE FOREX MARKET

FIGURE 5.11 By filtering the Composite COT with a percentile (COT Index), sig-

nals are provided more objectively. Tops occur when the COT Index is at 100 and

bottoms occur when the COT index is at 0

Source: Chart created on TradeStation

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, the flagship product of TradeStation Tech-

nologies, Inc.

long 59,864 contracts in November 2006. From this information, we would

conclude that there was a higher probability of a top occurring in Novem-

ber 2006 than in December 2004 because speculators were more bullish

in November 2006...or were they? A closer look at the COT data is essen-

tial to properly understanding a market’s psychological state. In December

2004, the breakdown for speculators was 41,235 long contracts and 2,449

short contracts for a net long total of 38,786. Of all speculative positions, 94

percent (41,235 ÷ [41,235 + 2,449]) were long positions. In November 2006,

the breakdown for speculators was 80,509 long contracts and 20,645 short

contracts for a net long total of 59,864. Eighty percent (80,509 ÷ [80,509

+ 20,645]) of speculative positions were long positions. The two situations

are quite different. A higher probability exists that a top will occur when

94 percent of all speculative positions are long as opposed to 80 percent.

% Long = # long contracts ÷ (# long