Insider Trading Information

INSIDER TRADING INFORMATION        

There is one more source of information that stock and spot forex currency traders can borrow from the futures industry. It is the Weekly Commodity Futures Trading Commission’s Commitment of Traders (COT) report. The CFTC market surveillance staff closely monitors trading activity in the futures markets in order to detect and prevent instances of potential price manipulation. Some consider this “insider trading” information because every week we get to take a look at which investor group is taking which side of a trade. (There are many studies and books written on the subject. In fact, it was covered in my first book on pages 162-165.)

As a futures trader for over 26 years, I have used this information to capture many significant moves in the markets. Figure 1.37 shows that there are several categories. The first is the “non-commercial”—all large professional traders or entities, such as a hedge fund, a commodity trading advisor, commodity pool operators, and locals on and off the exchange floors.

Any trading entity that hits a reportable position limit (for instance, in the CME currencies, at the end of 2005, the limit was 400 contracts) is reported by the clearing firm to the exchange, which then turns the information over to the CFTC.

The next category is the “commercials”—banks and institutions or multinational conglomerate corporations looking to hedge a cash position. The long and short open interest shown as “non-reportable positions” are derived by subtracting total long and short “reportable positions” from the total open interest. Accordingly, for non-reportable positions, the number of traders involved and the commercial/non-commercial classification of each trader is unknown. This balance of positions is assumed to be the small speculators. If you look at the first column under non-commercials, you will see the breakdown of long positions versus short positions. The next line down shows the changes from the prior week; this is important information because you will be able to see if these guys unloaded some of their positions or added to them from one week to the next. The line under that tells you the percent of longs and shorts that are held. The last line shows how many traders there are that control longs or shorts. The information is gathered as of the close of business every Tuesday by each of the clearing brokerage firms and is turned over to exchange officials, who then report the information to the regulatory body know as the CFTC. This information is released on Friday afternoons at 3:30 p.m. (ET).

It is critical before acting on a decision based on this information to see if there was a major price swing from Tuesday’s close to the time the information was released on Friday, because positions may have changed hands. For example, in Figure 1.37, if the British pound was at 1.7400 at 5 p.m. on Tuesday and the price at Friday’s close was 1.7000, it will indicate a 400-point move. If the COT showed small speculators net long, I will assume that the speculators were no longer long, as not many small speculators can handle a 400-point loss.

Can traders benefit and make money from this information? The answer is that there is always a chance to make money. The key is to be able to afford to be not too heavily leveraged if the market moves further than anticipated. The COT is like an insider information report. It acts like a true consensus of who literally “owns” the market. A forex trader can use this data to determine in a long-term trend run if market participants are too heavily positioned on one side of the market. It is generally the small speculator who is lefty holding the bag. Let’s face it—money moves the market, and the banks and large professional traders are a bit savvier when it comes to their business. After all, one would think a bank has a good idea of what direction interest rates are going to go once a central bank meeting occurs, right?

Suppose the small speculators are showing a nice short position of, say, at least two longs for every one short. If the non-commercials are net long and the commercials are net long, chances are that the small speculators will be wrong. I am looking for imbalances in markets that have been in a trending market condition for quite some time, and therefore I can develop a game plan and start looking for timing clues to enter trades accordingly. Keep in mind that the commercials sometimes are not right; they are not in the market to time market turns. They are hedging their risk exposure in a cash position. Therefore the non-commercials, or professional speculators, in the short term are considered the smart money.

Here are some general guidelines to follow for using the COT Report:

• If non-commercials are net long, commercials are net long, and the non-reportable positions category is net short by at least a two-to-one margin, look at buying opportunities. In other words, go with the pros.
• If non-commercials are net short, commercials are net short, and the non-reportable positions category is net long by at least a two-to-one margin, look at buying opportunities.
• If non-commercials are net long, commercials are net short, and the non-reportable positions category is neutral, meaning not heavily net long or short, look at buying opportunities and stick with the smart money speculating non-commercials.