COMMITMENT OF TRADERS ANALYSIS

The CFTC (Commodity Futures Trading Commission) is a government agency responsible for monitoring the futures industry. It requires that large traders holding positions above a specified level to report their positions on a daily basis. The CFTC compiles this data and releases it to the public every other Friday. These large positions are broken down into two categories: Commercial & Non-commercial.

Commercials or "Hedgers" deal in the cash market and consist of two groups: Producers & Consumers. Producers such as farmers, mining companies, and mutual funds, benefit from higher prices. Thus, they are at risk to declining markets. When prices are high, producers will hedge their futures sales by selling futures to minimize risk. If prices fall, they will be protected by their futures position. The losses that they have sustained in the cash market will be offset by their gains in the futures market. The futures market acts as an "insurance policy."

Consumers of the commodity markets also benefit from this "insurance policy." Food processors, oil refineries, and manufacturing companies are all examples of consumers. Their objective is to minimize costs. Thus, they are at risk to higher prices. When prices are low, consumers will hedge their future purchases by buying futures. If prices increase, their losses in the cash market will be offset by their gains in the futures market.

Unlike the Commercials who's objective is to minimize risk, the Non-Commercials or "Large Speculator" accepts the risk in return for the opportunity to profit. The "Large Speculator" generally consists of trend-following commodity pools. These commodity pools are to the futures industry what the mutual funds are to the securities industry. They are well funded and have deep pockets. They can afford to trade the trend which allows for larger drawdowns and sometimes requires them to ride out reactions, thus giving back some profits. This group is dominated by computerized trading systems that are similar in nature.

How can you capitalize on this information?

As most of us know, there are basically two ways to trade the futures market: Technically and Fundamentally. The majority of traders have a purely technical approach with total disregard to the fundamentals. While this can be profitable, it can also allow a trader to be completely blind-sided by the market. It pays to know the fundamentals. The fundamentals allow you to anticipate where the market is heading.

But trading purely on fundamentals is very dangerous. Fundamentalist calculate a value for a specific commodity based on the laws of supply and demand. At some point, the commodity may become cheap or expensive in relation to the supply and demand. Unfortunately, the value of a commodity is not determined this way. It is determined by what the market is willing to pay for it.

We use the Commitment of Traders Report to determine what the fundamentals of the market are. We believe that the Commercials who deal in the cash markets on a daily basis know much more about the fundamentals than we do or anybody else for that matter. Therefore, it pays to know what they are doing.

We use a couple of tools to help us identify potential trading opportunities. First of all, we calculate the COT Index. If the COT Index rises above 90%, a buy signal is generated. If the COT Index falls below 5%, a sell signal is generated. In addition to this, we also look for the net position to be near a three year record (long or short). If both of these conditions are satisfied, we will use technical analysis to identify a change in trend and issue specific trade recommendations.

By following these methods, a trader can definitely capitalize on this market information. The Commercials have an excellent record of anticipating market turns. Sometimes you may wonder why they are trading in the opposite direction of what the current fundamental view is. Who knows why. It doesn't matter. It will probably be more evident in the future. But without a doubt, when they speak, it pays to listen.