COT Report-based Forex strategies

COT Report (Commitment of Traders) is one of the most important provider of volume data in Forex. It is published by the Commodity Futures Trading Commission every Friday, around 2.30 pm EST.
Traders are particularly concerned with the role that volume plays in driving currency price. In stock markets volume is easily identifiable, but in Forex markets data are not provided on a daily basis. In order to get more information a trader may look at the COT report.
Forex transactions are normally made over-the-counter, e.g. on a daily basis and without the formal registration in one database of the real players and real investments involved. Without the collection of this information, it becomes impossible for a trader to quantify the market volume. The COT report allows him to do this, because it registers what happens in futures market. These markets are ones where traders need to keep their positions open for more than one day, so that forex market watchdogs are able to observe what and who is influencing price volatility. By being obliged to keep their positions open for more than one day, traders allow to quantify volume.
Relevant is to decipher some important terminology in this report:
Commercial – big companies that use the futures market to hedge against some other asset class.
Non-commercial – mixture of retail, hedge funds and financial institutions that play the game not to hedge but to win.
Short – number of positions open that are selling futures contracts
Long – number of positions opens that are buying futures contracts
Open interest – orders that were not yet executed
Is building a trading strategy based on the COT report possible? Yes, provided that a trader fully understands where volume of the market and positions of the different types of investors are. The report allows a trader to identify three main types of investors – hedgers, large and small investors – so that he can set up two strategies:
Reversals (Spread) – When the spread between commercial hedgers and large investors is big, then a trader should expect a market reversal. This can easily be explained by understanding that large investors are normally accumulating their positions around key reversal points. When this happens is a sign of a potential reversal. If the spread between the large investors and hedgers is high, and it reaches a peak, then it means that the market is in a tipping point towards a potential reversal that a trader can catch in its infancy.
Reversal (Large traders) – This is another trading strategy which looks at the importance of large traders in determining where the market will go next. When large traders start to reverse their positions (i.e. the large investors line’s trend starts reversing), a market reversal is expected most of the times.
While it’s very useful to spot trends reversals, the COT report does not provide “rules of the thumb”. This information is more relevant for long-term trades but it needs in any case to be corroborated by other information and knowledge of other forces that move the market, in order to be profitable.

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