Trade Stocks and Commodities with the Insiders: Secrets of the COT Report

CHAPTER 10

A Unified Theory of COT Data

It’s all very well in practice, but it will never work in theory.

It’s time to start to put the pieces together to fully understand the “Commitments of Traders” (COT) reports and create an indicator we can use—one that encompasses what we have come to know about the commercials, large traders, and small speculative traders. Heretofore, the industry has simply looked at the net commercial position or used the three-year look-back index discussed in Chapter 4. It is now time to go beyond these indicators and take a step forward.

What I have found to work better than the old indicators is to look at the commercials as a percent of open interest (OI), as opposed to just looking at the commercials versus themselves. We want to look at them versus all market action. Thus when OI is increasing and it is the commercials doing the increasing by adding short sales, a market peak should be close at hand, and vice versa.

Let me introduce this with a trade setup I saw, and wrote about for the leading financial paper in Japan. What you are about to read was written the last week of November 2004. Not a word has been changed. This is exactly what traders all over Japan read in early December 2004.

While the forecast is interesting, please pay attention to the indicator explained, as we will be doing more work with it.

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