Due to the timeframes most commonly used by a forex trader, we best not focus on longer-term macroeconomic analysis right now.
Instead, you are going to gain your Global View by piggybacking on Hedge Funds. For you, this will be a simple case of “is the industry net long or net short”.
Remember, these guys do all their own research, so if the common theme is that the EUR/USD is “net short” that means they are bullish on the US economy whilst reserved about the Eurozone.
This is because they are buying dollars and selling euros. Therefore, shorting the EUR/USD.
Simple, right?
(Also, this is a quick trick with forex trading for beginners as you can get a whole industry view in seconds)
As we quickly discussed on Section 7 about US economic data, this is our key focus because the majority of currencies are pegged to the USD. Therefore, what goes on in the US will have an impact on the majority of the Major currencies.
So we can capture this data by looking at one simple report and record it every week.
This is called the Commitment of Traders report – AKA – COT Report.
This is reported every Friday and we can use our Framework to track it.
How To Trade The Commitment Of Traders Report: Build A Reliable Market Sentiment View
This is a very quick way of building an image on what the smart money (institutions, hedge funds, banks etc.) is doing.
We simply read the free to view Commitment of Traders report every Friday.
The Commitment of Traders report prints the net long & short positions by speculative and commercial traders.
Simply put it, if we see a net short (negative figure) you are looking for sell/short ideas in that asset.
If we see a net long (positive integer) then you are looking for buying/long ideas in that asset.
As you record the figures down each week, if the figures are reducing/increasing then that is a sign of weakening/growing confidence in the positions.
For example, it would be rare if in 1 week large net long positions would become net shorts. It normally takes 3-4 weeks for the shift to happen.
This gives you an accurate picture of where smart money (institutions) are placing their trades.
Why is this important?
It is important because you are becoming a trader that understands the flow of money. Like a car in a traffic jam, it is much easier to go with the flow of the traffic than drive against it.
If the smart, well-researched, institutional money is betting on growth in EURUSD – we would rather be looking to go long on EURUSD as well.
This can simultaneously filter out poor, reactionary trades.
Remember, our job isn’t to beat the market – but to enter it at the right time and take a profit from it.
Equally, if you saw that the COT report showed EURUSD was net short, you would not be looking for buying opportunities.
So when you see a reversal in the market, such as a head and shoulders pattern and the general market sentiment is net short – then this would be a high-quality trade.
Makes sense?
Essentially, the smart money is the flow of traffic and we want to join it.
What do I do?
This is a reason why we just focus on several pairs to learn with.
Every Friday/Weekend, you update your report with the currency’s figures. This will give us the previous forex trading week’s bias going into the following trading week.
The more you do this, the more data you will have which allows us to analyse the markets as a whole over time. Each month there are 4 reports and we will be able to deduce market shifts if we monitor this report weekly.
This is not a LONG TERM VIEW
This is just to see which side the smart money is on, therefore to have/ or “borrow” a very limited and short-term view on the Forex pair.
This is a quick view of where money is being placed and should not form your opinion.
If you are looking for a long-term view, we will go through that process in an advanced class where we talk about endogenous and exogenous research and mirror exactly what Hedge Funds do.
EUR/USD Example
Step 1: Go to http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm
Step 2: Find “Current Legacy Report” further down the page and then click on “Short Format” under “Futures Only” heading on the “Chicago Mercantile Exchange”.
EUR/USD Example
Step 3: Look for EuroFX (EUR/USD Future name)
Quick Tip: Use Ctrl + F / Cmd + F & type in the currency to find it quicker e.g) “Aus” / “Eur” etc.
Step 4: Note down the long and short positions + changes from the previous week.
Step 5: Note down momentum (Change in contracts, are we seeing faster growing/contracting figures – which side is the momentum on? Short or Long)
Explainer
So in this example, we can see that the majority of contracts are net long (179,515 vs 149,875) – therefore, the momentum is behind the buy side.
We can see that in the second row (changes from…) that there has been an increase of 2,125 new long contracts since the previous COT whilst a -6,108 short contracts changed since the previous report.
What does this tell us? Momentum is being taken away from the short sellers and added to the buyers.
This gives us a snippet, and a very temporary view that we’d expect strength and an increase in the EUR/USD – should nothing drastic happen in the near future.