That’s right! Mini-lesson time! And you outta really like this. For some it’ll be old news with some small fresh new stuff thrown in. For many I hope this will be a real eye-opener.
Ever wonder what the real big, smart guys are doing? Aside from buying AND selling everything (and that’s why we have a market), there are definite patterns of posture (bullish or bearishness) toward the currencies by the “smart money” – controllers of huge positions. It’s not a silver bullet, but it actually is a veritable tea-leaf to be read by the savvy trader. And this coming from a no-BS realist…
Where do I go to see data on Institutional trading? There’s good and bad news here, folks. The bad news: none of us “normal” people are going to see who’s buying and selling how much of what (called “order flow”) which is the way to make money in this business. It’s kept private by banks and brokers for their own nefarious purposes.
The good news is we can at least see what institutions are holding and when, as a herd, they switch (albeit delayed). It’s called the Commitment of Traders (COT) report, found here (also linked above under Useful Organizations). Chicago Mercantile Exchange is what you want – just do short format, options and futures, although Chiacgo Board of Trade is good for stocks and bonds. The website explains how to read the report by the way.
Below is an example of the current COT, for the loonie:
Who’s who? What I call Institutional Trading they call Commercials. Commercials are basically the true big boys, the smart money. They trade a lot of money in the spot market (where most of us trade FX), but also, obviously, a lot in futures and that’s what we’re looking at. Non-commercials, well, that’s us. Call us the not-so-smart money, the weak hands, the gazelles that nimbly leap about the herd.
What to pay attention to: Basically the idea is that the non-commercials are wrong at big turning points. That is a major tenet of contrarianism by the way. This COT stuff is sort of contrarianism, though really we’re looking at Commercials. Spot the turns in Commercial positioning, which is either long (they’re buying) or short (selling). Remember that it is for a currency, not pair, so the currency in a pair may be denoted backwards (USD/CAD – CAD is going up as the pair goes down).
How it works: To understand this you have to understand dollar-cost averaging (DCA). When I ran my brokerage office we were big on this for retirement. DCA is consistent buying over time, like what someone does with their 401K.
Now, the “big money” thinks very differently than we do. Here’s the clincher: they DCA buy as they forecast prices going down, and they sell as prices go up. It’s a crazy world, I’m tellin’ ya! It’s like they are reducing their cost basis/taking profits, figuring it will eventually turn around. They do not time things like we do, they are long term in their investing, and they are pretty dang good at understanding where prices are going. Since they do not time, they can be weeks off on their moves, so if they start being bullish don’t expect it to turn around this week or the next.
What to do: If you see the big money reverse their position and start doing the opposite, maybe give it a week or two and then seriously consider adopting that posture, meaning start to look to get in/out of positions going that direction. Investools students have a serious advantage in that this data is charted and easy to read, so these decisions are technical in nature. Hooray for technicals! *note that we’ve already “translated” the DCA thing: the institutional line moving up for a currency really means institutions are selling, which means they are bullish! Follow that line!
Below is an example:
Notice how the institutional money not only went up, but it crossed over the price on our chart here. We can call this a bullish divergence, gang. Currently the price has gone down a bit, without a hint of let-up from institutions … careful in getting too frisky about the loonie returning in force right now.
The COT website’s downfall: is that it is raw, current data, like a snapshot. We can’t see whether the amount everyone is short/long is high or low relative to historic prices. And we can’t see if the positions are rising or falling week to week. This is huge! The value of the data is limited unless you shell out money for software (usually over $100/month) that focuses on COT, or use the Investools website.
A final word, on open-interest: Open interest works like volume does for stocks: we prefer to see it rising as the price goes in a direction, because this indicates strength for that direction. The COT site only gives that snapshot of open interest, but there’s your heads up how that works.
Remember, no system is perfect right? Neither is this. The EUR/USD COT chart has been screaming bearish for months, but remember, they can be off in the timing by months and eventually something has to give and it’s likely not the big boys. So take it with a grain of salt and adopt this measure as a part of your posturing tools. No study, be it pivot points, MACD, RSI, etc. is perfect, and nor is this, but it is an awesome piece of the puzzle! Enjoy.
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