Forex Trading Advanced Level Course
    About Lesson

    Pick Tops and Bottoms With the COT Report

    While hedgers buy when the market is bottoming, speculators sell as the price decreases. Here’s that COT report chart again:

    Hedgers are bearish when the market moves to the top, while speculators are bullish when the price is climbing. As a result, speculative positioning indicates trend direction, while commercial positioning could signal reversals. If hedgers keep increasing their long positions while speculators increase their short positions, a market bottom could be in sight. A market top could occur if hedgers keep adding more short positions while speculators keep adding more long positions. Of course, it’s challenging to determine where a sentiment extreme will happen, so it might be best to do nothing until signs of an actual reversal are seen.

    We could say that speculators because they follow the trend, catch most of the moves BUT are wrong on turning points. On the other hand, commercial traders miss most of the trend EXCEPT when the price reverses. Until a sentiment extreme occurs, it would be best to go with the speculators. The basic rule is this: every market top or bottom is accompanied by a sentiment extreme, but not every sentiment extreme results in a market top or bottom.

    Create Your COT Trading Indicator

    Below is a step-by-step process for creating this index. Decide how long of a period we want to cover. The more values we input into the index, the fewer sentiment extreme signals we will receive, but the more reliable it will be. Fewer input values will result in more signals, which might lead to more false positives. Calculate the difference between the positions of large speculators and commercial traders each week. The formula for calculating this difference is Difference = Net position of Large Speculators – Net position of Commercials.

    Take note that if large speculators are extremely long, this would imply that commercial traders are extremely short. This would result in a positive figure. On the other hand, if large speculators are extremely short, that would mean that commercial traders are most likely extremely long. this would result in a negative figure. This would result in a negative figure. Rank these results in ascending order, from most negative to most positive. Assign a value of 100 to the largest number and 0 to the smallest figure. And now we have a COT indicator!

    This is similar to the RSI and Stochastic indicators discussed in earlier lessons. Once we have assigned values to each calculated difference, we should be alerted whenever new data inputted into the index shows an extreme 0 or 100. This would indicate that the difference between the positions of the two groups is largest and that a reversal may be imminent. Remember, we are interested in knowing whether the trend is going to continue or if it is going to end. If the COT report reveals that the markets are at extreme levels, it will help pinpoint the tops and bottoms we all love.