The Commitments of Traders Bible: How To Profit from Insider Market Intelligence: 325 (Wiley Trading) - Hardcover

Briese, Stephen

Hardcover

ISBN 10: 0470178426 ISBN 13: 9780470178423

Publisher: Wiley, 2008

Synopsis

Regardless of your trading methods, and no matter what markets you’re involved in, there is a Commitments of Traders (COT) report that you should be reviewing every week. Nobody understands this better than Stephen Briese, an industry-leading expert on COT data. And now, with The Commitments of Traders Bible, Briese reveals how to use the predictive power of COT data―and accurately interpret it―in order to analyze market movements and achieve investment success.

About this title

About the Author

Stephen Briese is the leading expert on analyzing the Commitments of Traders data published by the Commodity Futures Trading Commission. Briese has published a newsletter, Bullish Review, since 1988 and has written articles for several industry publications and spoken at a variety of industry trading and technical analysis conferences.

From the Back Cover

Praise for The Commitments of Traders Bible

"This book provides an important understanding of how the crowd operates in the markets. Steve Briese has given us a complete explanation of the metrics that are required to actually use contrary opinion methods."
―Woody Dorsey, President, Market Semiotics, and author of Behavioral Trading

"Steve Briese is the master of the COT and here gives us the benefit of many years of experience in using the Commitments of Traders reports in his trading. Steve guides us, with wit and humor, through how the COT is calculated, why it is valuable, and, more importantly―how to use it to uncover an edge in your trading and investing. You will profit from this book."
―Charlie Wright, Chairman, Fall River Capital, LLC

"I have followed Steve Briese's analysis for two decades in trading the commodities markets. His methods and conclusions from COT data are fact based and often properly contrarian. In today's world, where commodity hedge funds have become even larger players, Steve Briese's work assumes an even higher importance level for commodity market participants, individual and professional alike."
―Brent R. Harris, Head of PIMCO Real Return and Commodities Desk; Chairman, PIMCO Funds

From the Inside Flap

The Commodity Futures Trading Commission's weekly Commitments of Traders (COT) report has established the U.S. futures market as one of the most transparent exchanges in the world―and created a level playing field for commodity and futures traders of all sizes in the process. But the information found within the COT report extends well beyond the confines of the commodity pits and can be profitably applied to virtually any market sector, from equities and treasuries to forex, gold stocks, and exchange-traded funds.

Nobody understands this better than author Stephen Briese, an industry-leading expert on COT data. And now, with The Commitments of Traders Bible, he shares the insights and experiences of his successful career to help put the COT report in perspective. Written in a straightforward and accessible style, this detailed guide skillfully examines the predictive power of COT data and reveals how you can accurately interpret it in order to analyze market movements and make the most informed investment decisions possible.

Divided into two comprehensive parts, this reliable resource:

• Takes you through a brief history of the COT report and explains how it has evolved over time
• Illustrates how the dozens of numbers published on specific markets expose the positions of the biggest and smartest market insiders
• Describes how to properly view the COT Index and use it to avoid the traps that most observers fall into
• Offers technicians and chartists various ways to incorporate COT analysis into their existing programs
• Discusses individual idiosyncrasies and patterns that appear in certain markets―from oil to interest rates
• Lists hundreds of securities from all over the world whose prices are highly correlated with commodities contained in the COT report

Regardless of your trading methods, and no matter what markets you're involved in, there is a COT report that you should be reviewing every week. With The Commitments of Traders Bible as your guide, you'll gain an invaluable edge over uninformed market participants as you learn how to use legal "insider" information to enhance your everyday investment endeavors.

Excerpt. © Reprinted by permission. All rights reserved.

The Commitments of Traders Bible

How To Profit from Insider Market IntelligenceBy Stephen Briese

John Wiley & Sons

Copyright © 2008 Stephen Briese
All right reserved.
ISBN: 978-0-470-17842-3

Chapter One

The COT-Assorted History

"Look," began the spokesman when the door closed, "the Grain Futures Administration has made a complaint that you are carrying too much open stuff." It would be hard for me to make anyone other than a La Salle Street trader understand how I felt then, unless it might be some Russian farmer who has tasted the bitter flavor of government interference in matters which should not concern it. -Arthur W. Cutten and Boyden Sparkes, "The Story of a Speculator," The Saturday Evening Post (November 17, 1932)

My great-grandfather A. E. Briese went bust four times in his life; the first was in 1918, in commodities. He had been growing potatoes to feed the troops during World War I, and loaded his crop on railcars at Plainview, Minnesota. Then the war ended, and the Army canceled his contract. He wasn't alone. Farmers across the country ramped up to meet demand for wheat, corn, and oats, brought on by the Great War and the Russian Revolution and famine of 1917. And nobody was hedged (only partly due to the closure of the Chicago Board of Trade during the war). Wheat prices, which reached almost $3.00 per bushel during the war, began eroding, along with land values, immediately following the Armistice. When the Chicago Board of Trade reopened in 1921, there wasn't an empty grain bin or railcar in the country, and pit prices reflected the overwhelming supply. At least farmers now had somebody to blame besides the government: the Chicago grain speculators.

THE GRAIN FUTURES ADMINISTRATION

Congress, which was dominated by farm-state members, was quick to respond to the crisis, passing the Grain Futures Act, signed by President Warren G. Harding in 1922. The act, for the first time, required Chicago Board of Trade (CBOT) members to report their aggregate trades to the newly formed Grain Futures Administration, which posted these figures in its first annual report to Congress in 1924. From the beginning, a key feature of the report was to differentiate speculators from the "trade" (commercial hedgers who used futures markets to protect their ongoing cash business from price volatility).

In response, the Chicago grain traders first sued (unsuccessfully) to maintain their trading privacy, and then formed the Board of Trade Clearing Corporation in 1925 (now the Clearing Corporation) to provide trader anonymity in aggregating and reporting trades. Even though position sizes were only informally controlled (by the CBOT's Business Conduct Committee), large traders like Arthur Cutten-who by 1926 took delivery of 5 million bushels of wheat-were contemptuous of government oversight, an attitude that continues among certain large traders to this day.

THE COMMODITY EXCHANGE AUTHORITY

Monthly reporting continued under the Commodity Exchange Authority (CEA), created by the Commodity Exchange Act of 1936. This act empowered the CEA to establish speculative position size limits as well as prosecute market manipulators, and banned option trading on commodities-a restriction that was not lifted until 1982. This act, and subsequent amendments, added markets to the CEA's portfolio (Table 1.1).

In 1942, the "Commodity Futures Statistics" report was published separately from the U.S. Department of Agriculture's USDA annual report. The new publication included monthly trader statistics (though still published annually). The CEA published the first monthly Commitments of Traders (COT) report on July 13, 1962. This listed large trader positions for 13 agricultural commodity markets as of June 30.

THE COMMODITY FUTURES TRADING COMMISSION

Congress created the Commodity Futures Trading Commission (CFTC) to succeed the CEA in 1974. By this time, several additions were made to the COT (Commitments) report, including adding data on the numbers of traders in each category; a new-crop, old-crop breakout; and concentration ratios that show the percentage of open interest held by the four and eight largest traders. Under the CFTC, the COT report release interval has been incrementally shortened beginning in 1990 with mid-month and month-end reports, to every two weeks beginning in 1992, and to the current weekly schedule in 2000. The delay between tabulation and release has been shortened, as well, and you can now collect the data at the CFTC's website at 3:30 P.M. eastern time each Friday (from tabulations made on Tuesday's close).

By appearances, the Commitments report is little changed during its first 45 years, but looks, as they say, can be deceiving. Although the format available at the CFTC's website is very similar to the pre-1982 report (Figure 1.1), numerous subtle changes have affected both the nature of the large trader reported and the analysis of the report. You will not find a quiz at the end of this chapter, but I will highlight the evolving nature of the COT report so that you can appreciate how earlier authors may have offered a different take on analyzing the report's contents.

I first became aware of the COT report soon after beginning my trading career. My choice to trade commodities was really a matter of timing. In 1973, when I became interested in investing, stocks were locked in their worst bear market since the Great Depression. After studying all of the various investment possibilities covered by Morton Schulman's Anyone Can Still Make a $Million (Schulman 1973), I settled on commodities. I went long three silver contracts at $3.97 and made $1,500 my first week. I guess I will never forget my father's response, "That's a pretty good living if you can do it every week."

There were not a lot of commodity books in print in those days, so I dove into Larry Williams's How I Made One Million Dollars Last Year Trading Commodities, when it was published (Williams 1974). One of his key resources was something called the Commitments of Traders report, so I immediately subscribed. It was a free subscription in those days, with separate reports mailed from Chicago and New York on about the 11th of each month, covering the previous month's trading.

You undoubtedly have heard the old market saying that the easiest way to make a small fortune trading commodities is to start with a large fortune. Larry's contention was that traders became large by anticipating market moves. I'm oversimplifying Larry's techniques when I tell you that he recommended using the COT report "to alert you to the `deals' you should be scouting out" (p. 96) by comparing the size of large speculator long positions to their short holdings. If large noncommercials are overwhelmingly long, look for a long trade; look to go short if large speculators are net short. He specifically warned against using the Commitments report for trade timing-understandable, since it was a monthly report that reached you halfway through the following month.

THE MODERN COT DATA

During the 1970s, the large noncommercial category was most likely dominated by large individuals la Richard Dennis of Turtles fame. In the 1980s, this began to change as commodity funds gained popularity (including several that were run by former Turtles). So, too, did the interpretation of large speculator positions. In 1982, the CFTC stopped requiring large traders to report their own positions (on Series '03 forms). Their stated intent was to improve efficiency and the timeliness of the COT report by eliminating reliance on a form that was typically sent by mail. The new routine relied primarily on Series '01 reports of large traders' positions filed on a next-morning basis by Futures Commission Merchants (FCM or broker) together with Form 102, which identified large traders who held accounts with multiple FCMs. Notably, large traders were required to file Form 40, and Schedule 1, identifying any positions used for hedging purposes. The daily reports by the brokers provided the critical information on actual trading positions.

There is a bit of a dispute over why the CFTC ceased publishing the report in 1982. The Commission maintains today that it suspended publication "in order to implement computer changes." Commodities (now Futures) magazine reported in 1983 that "the CFTC stopped handing out the free, photocopied booklets when production costs soared" (Commodities December 1983). Nobody seems to dispute the magazine's account that the report was reintroduced in December 1982, "after a deluge of requests for the publication" (1983). Adding to Commodities' credibility, the COT reports were reintroduced as paid subscriptions, priced at $0.10 per page (about $5.80 for the Chicago report, and $2.30 for New York's).

The combination of the publishing gap, the changes in the reporting regimen, and the revised reporting thresholds instituted in 1983 made the earlier data useless for historical comparison. Because a single Commitments report provides no context, it is not particularly enlightening in itself. Trader position levels must be compared to their historical range to judge whether current positions might be out of the ordinary and perhaps useful for forecasting price trends. It was not until 1985 that enough new history was available to make much sense of the Commitments report. Thus, the total gap in usable Commitments reports was close to five years. I refer to post-1982 as "modern data" and all of the current methodologies and conclusions included in this book are based exclusively on post-1982 Commitments reports.

The CFTC made another change in 1982, one that received no attention until 23 years later when the Commission pointed to it as effectively serving notice of a change in the fundamental tenets that had governed large trader categorization since the beginning. In 1983, the COT reports began listing the trade as "commercials" instead of the previous heading of "hedgers." If this seems like nothing more than semantics, you are right. The regulations clearly defining who was a legitimate hedger were never changed, but in 2006 the CFTC pointed to the revised heading in justifying the dumping of swap funds ("commodity index traders" or "nontraditional commercials") into the commercial category.

COT OPTIONS AND FUTURES COMBINED REPORT

In 1995, the CFTC, which was publishing a COT report for New York futures, and a Chicago report that covered the Kansas City Board of Trade along with the Minneapolis Grain Exchange, added two new COT reports that combined the options open interest with the underlying futures positions. This COT Options and Futures Combined report began with zero historical data provided, so it took a couple of years to accumulate enough data to interpret it intelligently.

When sufficient Options and Futures Combined data was available to compare to the Futures Only, there were noticeable differences in scale, but the proportions were very similar to the Futures Only trader positions. On a percentage basis, the long and short open interest held by each of the trader groups was very similar on the two reports. Technical studies such as the COT Index yielded nearly identical numbers, so there was little incentive to use the combined report, especially since a substantially longer historical record existed for the Futures Only report. This preference changed in 2007, when the Commission introduced a new supplemental report that was a subset of the data contained in the Options and Futures Combined report. All of the examples and charts in this book are based on the combined report.

COT-SUPPLEMENTAL COMMODITY INDEX TRADER REPORT

In June 2006 the CFTC undertook what it called a "Comprehensive Review of the Commitments of Traders Reporting Program." In describing the backdrop for the "Review," an astonishing admission was made: "The Commission believes that the public perception was, and is, that the "commercial vs. non-commercial" classification in current COT reports is analogous (if not identical) to the "hedging vs. speculation" distinction in the pre-1982 COT reports" (CFTC 2006).

The commodity bull market that began in 2002 had, as others before it, attracted a great deal of public notice. Paying $2.50 to $3.00 for a gallon of gasoline at the pump will catch the public's attention. This time around, however, the public was provided an alternative to opening a futures account. A number of commodity index funds were offered through mutual fund companies (and others) that were sold to the public primarily as passive investments intended to mimic a popular commodity index such as the S&P GSCI (formerly the Goldman Sachs Commodity Index).

An enormous amount of money was raised, but most mutual funds didn't have the expertise to manage actual commodity purchases or even commodity futures transactions. Along came swap dealers (derivative dealers who work outside the arena of regulated exchanges) to the rescue. They agreed-for a price-to provide cash flows equal to any increase in the particular commodity index of choice. To offset this risk, swap dealers bought commodity futures and options. (I need to interrupt this story to acknowledge an IRS ruling that stopped most mutual funds from dealing in swaps. This was quickly worked around, and the money still flows to the futures markets through the swap dealers.)

When swap dealers bought futures in large enough quantities to require large trader reporting, they soon found themselves up against speculative trading limits imposed by the CFTC (which is required by law "to protect futures markets from excessive speculation that can cause unreasonable or unwarranted price fluctuations" (CFTC Backgrounder, 2007). But the swap dealers successfully circumvented these restrictions by petitioning the Commission for "hedge" exemptions.

What is a hedge exemption? It is an exemption from position limits imposed on speculators, which is granted on a case-by-case basis for "bona fide" hedges. It is not a back door granting "hedger" status to swap funds who have no function in the market for the actual commodity. You are supposed to be a bona fide hedger to apply for the exemption. A bona fide hedge is intricately defined, and reads (in part):

A short hedge, for example, includes sales for future delivery (short futures positions) that do not exceed the amount of the commodity that the seller owns, has agreed to purchase (for a fixed price), or anticipates producing during the next 12 months. A long hedge includes long futures positions that do not exceed the hedger's fixed-price sales or 12 months' unfilled anticipated requirements for processing or manufacturing ... no transactions or position will be classified as bona fide hedging ... unless their purpose is to offset price risks incidental to commercial cash or spot operations (CFTC Backgrounder November 2006).

To hedge wheat (in excess of speculative trading limits), for instance, you must be a wheat grower, a flour mill, or a bread baker. In other words you have to get your hands in the wheat to hedge it. The only exception applies to a merchandiser such as a marketing cooperative. Nonetheless, the CFTC has issued "hedger" exemptions to swap dealers, who have since become the largest traders on the long side of commodity futures-at least in the contracts that are reported. This practice began under CFTC Chair Wendy Graham, wife of the former Texas senator, who left the CFTC to join Enron (McLean and Elkind 2003, 96).

Why should these exemptions concern us-other than $2.50 gasoline, $2.70 heating oil, $4.50 corn, $6.50 wheat, $12 soybeans, $2 OJ, $15 natural gas, $0.95 pork, $1 beef, $4 copper, $2400 cocoa (wholesale prices)? From a trading standpoint, the large commercial hedger category is the best available indicator of the price outlook of the trade, who are intimately involved with the underlying cash business. The swap dealers may be bright people too, but they don't know beans about soybeans. Intermixing their market positions with the trade's positions fogs our view of the true insiders.

(Continues...)

Excerpted from The Commitments of Traders Bibleby Stephen Briese Copyright © 2008 by Stephen Briese. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: Wiley
• Publication date: 2008
• ISBN 10: 0470178426
• ISBN 13: 9780470178423
• Binding: Hardcover
• Language: English
• Edition number: 1
• Number of pages: 312