“OI is rising – Price is rising – long“
“The number of shorts is increasing, which will push the price higher over time as they will eventually close their positions (buy).”
“OI is rising – Price is falling – short“
“Someone is buying, but soon they will be closing out their positions due to stops (selling), which will push the price down.”
“OI is rising – Price is unchanged (in range) – short“
“It is probable that large players are preparing for price declines.”
“OI is falling – Price is unchanged (in range) – long“
“Large players are closing out their positions – shorts (buying). Price increase is anticipated. Margin call may occur.”
“OI is falling – Price is rising – short covering“
“Longs are hurriedly closing out their positions, shorts are exiting due to stops. All major players are in doubt. Trend reversal tendency and short position.”
“OI is falling – Price is falling – long covering“
“Buyers exit through stops, shorts close out their short positions. Readiness for long positions.”
“OI is unchanged – Price is rising“
“Further upward movement is in question, the most profitable part of the trend is behind. Exiting the market.”
“OI is unchanged – Price is falling“
“Further growth is in question, the most profitable part of the trend is behind. Exiting the market.”
Reports from the Commitments of Traders (COT) represent a summary of open positions of all categories of market participants. The data is published weekly on Fridays on the cftc.gov website. The report consists of a table showing the buying and selling transactions of market participants, as well as spread transactions.
Of particular interest to traders is the Dealer column, which shows the open positions of brokers. In the Long and Short columns, purchases and sales are indicated respectively. Brokers execute orders on behalf of traders, and these transactions are listed in the report on behalf of the broker.
Therefore, for currency pairs where the USD occupies the second position:
- A Long position surplus indicates mass sales.
- A Short position surplus indicates mass purchases.
For currency pairs where the USD occupies the first position:
- A Long position surplus indicates mass purchases.
- A Short position surplus indicates mass sales.
The surplus of one column should be at least 30% of the total number of open transactions.
Thus, with the help of COT reports, a trader can assess the direction of the long-term trend.
Daily open interest reports are provided on the Chicago Exchange website. Open Interest (OI) is the total number of open buy and sell transactions in the market. Every day, changes in open interest are indicated in the reports, and the total number of open transactions may increase or decrease. Recently, OI reports have been provided in PDF format. Information is provided every day before the opening of the European session. Traders can assess market participants’ actions for the previous day.
- An increase in the number of open transactions informs the trader about new transactions in the direction of price movement.
- A decrease in the number of open transactions indicates partial closing of market participants’ transactions.
It is advisable to use OI data with consideration for the long-term trend. In a situation where the long-term trend is downward and a falling day with an increase in OI appears, the trader should look for sales. In the case of an upward trend, one should look for growing days with an increase in OI.
COT reports are one of the fairly effective methods of market analysis. It should be noted immediately that the information from COT reports is more suitable for traders trading medium or long-term positions.
Weekly, the CFTC (Commodity Futures Trading Commission) publishes complete data on transactions – purchases and sales for the previous week by three groups of traders on the website. Thanks to this information, a trader can see the depth of the market, its snapshot.
Let’s consider the classification of all market participants – three categories are distinguished:
- Hedgers or operators (Commercials). This is the largest group of market participants in most markets. Hedgers are the real sector of the economy. Typically, these are companies (product manufacturers) interested in buying or selling goods at favorable prices and actively hedging possible commercial risks from unfavorable price changes. Thus, for this group of participants, contrarian behavior is typical.
- Large traders or large speculators (Non-Commercial). This is the second largest group of participants in futures markets by size. In most cases, these are various investment funds and banks. Their main goal is to profit from the existing difference between the sold and purchased contract. In the market, their behavior can be characterized as “continuation of the trend” because their goal in the market is to take on the risk of hedgers and in return, gain profit. This group of participants is as important as hedgers because speculators, by taking on all the risk of hedgers, protect them, that is, protect the real sector.
- Small traders or small speculators (Non-reportable positions). These are market participants who operate with insignificant sums of money. This group is often seen as small speculators. Their goal is to profit solely from the difference. They are often referred to as dumb money because they generally suffer losses due to lack of experience, qualifications, and information.
The COT TFF (Traders in Financial Futures Report) divides all market participants into 4 categories:
- Dealer/Intermediary β dealers/intermediaries. This group represents the “Sell Side” of the market (they sell financial instruments to other participants, their profit consists of commissions and spreads). Companies in this category create and sell various structured products to their clients. They usually have all the information about the positions of their clients and offset their risks between clients and between different markets. Large commercial banks, securities dealers, swaps, and other derivative instrument dealers usually belong to this category.
- Asset Manager/Institutional β asset managers/institutionals. These are institutional investors, pension funds, insurance companies, mutual funds, as well as asset managers whose clients are institutional investors.
- Leveraged Funds β hedge funds. Registered CTA (Commodity Trading Advisors), CPO (Commodity Pool Operators), etc., also belong to this category. The strategies of these market participants include taking long/short positions in the market, as well as arbitrage between markets or within the same class of instruments. Prop-trading companies and speculative traders also fall into this category.
- Other Reportables β other reporters. These are all those who did not fall into the previous three groups. Traders in this group mainly use the market to hedge risks associated with production and business. This category usually includes corporate treasuries, central banks, credit organizations, and mortgage borrowers.
Here are the three approaches to COT data that can be used to forecast asset movement:
- Commercial Approach:
- This approach focuses on the actions of hedgers or commercials in COT reports.
- Hedgers protect their commercial positions in the market, making their actions often contrarian.
- Forecasting asset movement is based on analyzing whether hedgers are more active in buying or selling, which can provide insight into future price direction.
- Speculative Approach:
- This approach focuses on the actions of large traders or non-commercials in COT reports.
- Large traders often follow the trend and try to profit from price movements.
- Forecasting asset movement is based on analyzing whether large traders are more active in buying or selling, which can provide insight into future price direction.
- Combined Approach:
- This approach combines data from both commercial and speculative market participants.
- It allows for analyzing both commercial and speculative interests to gain a more comprehensive understanding of market direction.
- Forecasting asset movement is based on a combined analysis of the actions of both groups of market participants and determining the dominant direction.
Extreme Amount of Positions
Historically, an extraordinarily large number of trading positions in the currency futures market accurately identifies major market reversals. The reason for this phenomenon is the massive accumulation of speculators at these points, operating in the same direction, and there are no longer many buyers or sellers left. As a result, the movement exhausts itself, and the price reverses.
Changes in Open Interest
When analyzing the market, open interest is a secondary tool. However, its correct interpretation provides an understanding of market price dynamics. These data are useful primarily for investors and position traders, as they aim to profit in the long term. Open interest can be used to measure the strength, or conversely, the weakness of the asset price trend.
For example, in a prolonged downward or upward trend, open interest is increasing. A decrease or leveling off of open interest may be the first signal that the trend is nearing completion. Overall, a rise in open interest indicates that aggressive buyers or new money are entering the market and suggests that the trend’s strength is increasing. Conversely, a decrease in open interest suggests that money is leaving the market, and the trend is losing momentum. Thus, trends accompanied by decreasing volume and open interest are quite unreliable. Falling open interest and rising prices signal that the trend is nearing its end, as fewer traders are participating in the rally.
Working with COT data and their interpretation allows identifying medium to long-term market trends and is more suitable for investor and position trader strategies.
Market Sentiment β one of the most important driving factors of trading. Evaluating it is extremely important in trading practice, but unfortunately, it is often overlooked. There are various ways to measure the sentiment of the majority of market participants, but we will consider how this process is carried out using the analysis of the open interest indicator.
Forex Market and Open Interest
Analyzing the open interest indicator in derivative markets (futures, options) is a standard analysis tool, but for most traders trading in the spot forex market, this topic is unfamiliar.
Therefore, to obtain data on volume and open interest as important indicators of market movement in the forex market, it is necessary to use data on open interest and volume in the currency futures market.
Relationship between Spot and Futures Currency Markets
Unlike the spot forex market, which lacks a centralized trading platform and a unified accounting system, currency futures transactions take place on exchanges, such as the Chicago Mercantile Exchange (CME). These markets are highly interconnected, and data on volume and open interest in the futures market allow a trader to assess market sentiment in the Forex market. The price of currency futures is primarily determined by the spot market price, which differs by the size of forward swaps. The currency spot market involves a transaction with cash delivery within two days, while currency futures are traded based on standard contract sizes with a duration of three months.
The price of currency on the futures market and the spot market tends to move simultaneously and in the same direction, i.e., when the price rises on one market, it also rises on the other market, or vice versa.
Concept of Open Interest
Traders often confuse the concept of open interest with the concept of market volume.
It should be remembered that open interest is the total number of open contracts that have not yet been settled by delivery or offset by an opposing transaction. That is, these contracts are still “open.” When a buyer opens a new long position, the seller also opens a new short position on the opposite side, and the open interest increases by one contract.
It is also important to understand that if a new buyer buys from an old buyer who intends to sell (close the position), the open interest does not increase, as no new contract has been created. Open interest decreases when traders close positions. In the market, open interest in total long positions always equals the total open interest in short positions. This situation is explained by the fact that for each buyer, there is a seller, or as it is also called, a counterparty.
Relationship between Trend and Open Interest
In general, open interest increases when new money enters the market, and traders bet on the current market direction. That is, an increase in total open interest generally favors the current price trend and indicates its continuation.
Conversely, a decrease or no change in this indicator indicates that the trend’s momentum is waning and its end is likely imminent.
Therefore, rising open interest usually indicates the continuation of the current price trend, whether it is an upward or downward trend. Decreasing or unchanged open interest suggests that the trend’s momentum is weakening and its end is likely imminent.
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