Swing Trading Commodities with the COT

April 5, 2018 08:00 AM
The CFTC’s COT report can provide important data, particularly for swing traders.

Finally, these are swing trades. We expect an overextended market to reverse when the commercial traders carry an opposing sense of value. The discretionary trades are supposed to generate a reversal anywhere from a few to several days long. That’s it. Take the profits and run.

Here, we look at a snapshot of our COT signals from the spring of 2017. The “Treasury swings” chart, which appears earlier in the article, shows several successful swing set-ups in the Treasury complex. 

You can see that the Friday, April 7, the Unemployment Report created a swing trading signal on the short side in the five-year Treasury Notes as the commercial traders used the recent rally to unwind their record net long position. The 10-year Treasury note chart indicates that an overbought market plus negative commercial momentum generates a sell signal upon a momentum reversal.

The 10-year note futures show how consistent commercial selling during the previous four weeks accelerated on the unemployment report and created the resistance necessary to thwart Friday’s early rally. Their shift toward a negative bias ahead of the report created two losing signals.

During that same period a short signal appeared in the euro (see “Euro short,” below. Here is a simple illustration of the sell side of our COT methodology. You are probably beginning to notice a pattern between market prices and the commercial traders’ actions. The commercial traders are negative feedback traders. They buy more future inputs as prices decline and sell more future output as prices rise.

COT data produced a corresponding long signal in the U.S. Dollar Index during the same period based on our commodity trading method (see “Long dollar,” below). 

Commercials & Speculator Conflict

It all comes down to conflict. The bigger the conflict between the commercial and speculative traders, the bigger the pending move in the underlying commodity. Let’s close with a look at last spring’s record position in crude oil futures. News outlets were trumpeting the hedge funds’ collective forecast of a balanced market and record bullish position. Meanwhile, we focused on the speculative washout that we felt was necessary before crude could gain any serious upside momentum.

The record speculative long position couldn’t last forever. That washout allowed us to buy in at a much lower price, while also capturing short side profits. A strong long trade was indicated in heating oil. The losing trade took losses at the penultimate swing low that cued the crude reversal higher.

The heating oil futures provided a classic COT buy signal (see, “Classic COT buy signal,” on the previous page) to recoup the losses of the early long entry on March 10. To help we have created a Discretionary COT Signals worksheet (see “COT signals,” left). The third column is commercial momentum. Remember, we only take trades in line with the commercial traders’ momentum. The fourth column is the overbought or oversold reading, which will always be the opposite of commercial trader momentum. When the fourth column is lit up, we know there’s tension within that market and that it is ripe for reversal. However, we don’t take action until the market reverses to move back in line with the commercial traders’ momentum. Remember that the reversal also provides us with the protective stop price. 

This brings up two key rules in trading. First, never try to pick tops and bottoms, wait for some type of reversal. Second, never trade without knowing and adhering to your risk levels. The action column will always signal the buy or sell in the same direction as the commercial traders’ momentum, while the stop column provides the price for the position’s opposing protective stop loss order. 


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About the Author

Andy Waldock, owner of the brokerage firm Commodity & Derivative Advisors and the subscription service COTSignals.com, is a third generation commodity trader with over 25 years of experience on all of the main U.S. exchanges. Andy stays abreast of modern programming developments due to the trading programs he employs for his own account and managed money.  He can be reached at www.andywaldock.com.