Friday, June 15, 2007

The COT report

I want to talk a bit today about why I use the COT. You can get a brief view of my thoughts under the profile.
Generally speaking for me to use a system I have to not only be able to back test it and have it show a positive expectancy but it has to also make sense. I have tested the COT for the 20+ years that it has been available. During that time the COT has produced roughly 3 winning trades for every loser. On top of that the winning trades are much larger than the losing trades on average. That's about all anyone can ask for in the markets. As a matter of fact I've never found anything else that even comes close to producing those kind of returns. The challenge is to be ready to adapt as the COT evolves. Pre 2001 the flip zone was at 0 meaning that when the net commercial position was positive one went long and when it was negative you went short. However after 9/11 the world changed. At that point I think the commercial traders became aware that risks in the world had become elevated. At that point in my opinion, the zero line moved from 0 to a zone around the -15,000 level. All this means is that the big boys were always hedging to some extent because of geopolitical risks. At that time waiting for the commercials to reach a positive net became a losing proposition.
Now lets take a look at who the commercials are and why I think its a good idea to follow behind them and not stand on the tracks in front of them. The Commercials are for the most part large banks (think Goldman, JP Morgan, Lehman, etc.) or large pension funds, etc., etc. These are players that control billions and billions of dollars. In fact they control about 75-80% of the money in the markets. For all practical purposes the market is the commercial longs battling the commercial shorts. These are institutions that have huge research departments. They can afford to buy information that's just not available to you and me and they're going to get it weeks or months before we will. So when the COT position doesn't agree with the current fundamentals I have to keep in mind that yes maybe it doesn't agree with the fundamentals today but it might very well agree with the fundamentals 2 months from now. So I have a system that has produced superior returns, I can test it and be assured that it has worked for many years and on top of that it just makes sense to me. There you have it the reasons why I trust the COT to keep me on the right side of the market.