Commitments of Traders (COT) vs. Retail Traders Long Short Ratio's
Commitments of Traders,
The COT report and the various Sentiment Indexes measure market sentiment, unlike most other technical trading indicators they pay no attention to market price. The important information in Commitments of Traders report for us is the number of long and short positions held by non-commercial traders. Commercial traders are typically institutions using futures contracts for hedging. Non-commercial traders are typically large traders and hedge funds. The non-reportable positions are those positions that don't meet the reportable requirements set by the CFTC. In the example below there are 807,946 non-commercial long positions and 234,509 short positions; so we would say the speculators are NET LONG by a ratio of 3.44 to 1.
You can read more about the Commitments of Traders report here.
Retail Traders Long Short Ratio's,
The various retail traders long/short ratio indicators tell us the same thing as the COT Report's non-commercials long and short number, but the retail trader indexes consist of a very different type of trader. The non-commercial section of the COT data consists mainly of hedge funds and large traders, whilst the retail traders open position ratios consist of small retail traders. Hedge funds and large traders are mainly trend following in nature, this means these traders are usually right (except at market turning points) and that the largest number of these traders will end up on the wrong side of the market at major market turning points as the longer a trend continues the more large traders will recognise it and join it. Contrarian investors are usually wrong as contrarian investing only works at the extremes of investor fear and greed. 'Extreme' readings in the non-commercial COT data should therefore alert us to the possibility of the major trend turning, as the old contrarian saying goes:
"When everyone wants to buy the market must fall as there is nobody left to sell. When everyone wants to sell the market must rise as there is nobody left to buy.
When everyone is long the market will eventually collapse under it's own weight as there will be nobody left to buy and push the price higher, so the trend will end. The COT non-commercials have been on the wrong side of every major market crash. Extremes can last for a long time, so an extreme reading in the COT should only be taken as a warning signal; you should always wait for the market to actually turn. A signal of a potential market turning point might be a more extreme long/short ratio of the COT non-commercials than has been seen in the last 26 or 52 weeks, for example.
Small retail traders typically trade in the exact opposite way as the large speculators and hedge funds. They gamble, trying to pick short-term tops and bottoms. Picking tops and bottoms consistently is damn near impossible so the majority of retail traders are usually losing money as they fight the trend. When the market does finally turn the majority of retail traders will be on the winning side, when this happens they typically take a small profit and close their positions then end up wrong and losing money, again. In the financial markets (especially the Forex market) money tends to flow from the majority of small traders into the pockets of the few large ones.
DailyFX publish their Speculative Sentiment Index (SSI) readings weekly for free on DailyFX and publish readings for customers twice daily on DailyFX Plus.
OANDA publish the positions on their books at
OANDA's Open Positions Ratio their data is updated hourly and made available for free. This is my personal favourite as OANDA are a huge broker with worldwide reach so their sample is very likely to be representative of the world's retail Forex market as a whole.
FXOnline Japan publish their customers real time live long and short ratios for free at FXOnLine Japan's Long/Short Ratio. I do not believe this is nearly as useful as the ratio's from FXCM (DailyFX) or OANDA.
In Summary,
Market sentiment indicators differ from (most) other indicators in that they don't pay any attention to market price.
When taking a medium or long-term trade you want to be on the same side as the majority of large contract non-commercial traders in the COT report. These traders are mostly trend following in nature and are usually right.
You want DO NOT EVER want to be on the same side as the majority of small retail traders, these traders are essentially gamblers trying to pick short term tops and bottoms and fading the trend, the majority of these traders are usually wrong. Following them will most likely lead to disaster.
Market turns usually happen when the COT is showing an extreme reading, i.e. one position vastly outnumbers the other to an extent that hasn't been seen for a long time. Use these extreme readings as a warning flag against taking a medium or long-term trade. Extremes can last for a long time. As Keynes said, "the market can stay irrational longer than you can stay solvent" so an extreme COT reading should be seen as a warning signal against taking a trade, rather than a signal to bet on a trend reversal.
