MORE ABOUT COT
 

There are different groups of players, namely:

- producers (or users)

- speculators (subdivided into managed money and other speculators)

- swap dealers

- small traders

Users of physical commodity come to derivatives market to hedge their exposure. They are looking for protection not making money. How does it work? OK, imagine you are a risk manager at Nestle and your task is to secure prices for cocoa in 6 months from now. You know that today's price of $2,500 per ton is acceptable for the business and budgeted in the final product price and in 6 months you will need to purchase 1,000 tons of cocoa from African growers. You also know that in 6 months the weather will be adverse, crop prospects are not great, there is social unrest in Cote d'Ivoire or presidential elections in Ghana will be soon - everything tells you that the price will go up.  You go to ICE exchange and buy 100 cocoa futures (each is for 10 ton) at $2,500. In 6 months your purchasing department informs you that they bought 1,000 tons of cocoa at $2,700. You sell 100 futures at market price $2,700 and receive profit of $200 per ton. So, company paid $2,700 for actual cocoa and you made $200 on paper cocoa. Net price is $2,500. By buying futures you locked the price 6 months ago. And if the price would drop hedging would produce loses but net effect would be the same - $2,500 per ton. Another question is - would you be willing to lock the price 6 months ago if you would know all the inside info about prices likely to go down? Like the weather will be crop friendly, crops would be abundant and political leaders finally grew tired of waging endless fights? So this is important take away - when you see that producers (users) accumulated a large long (short) position this means they ANTICIPATE prices to grow (fall).

But every trade has two sides and if producers were buyers then who sold and why? Another group of players is called speculators and they are subdivided into two further groups - Managed Money and Other Speculators. Both of these groups come to the market to make money. Buy cheap, sell high - this is their motivation. They spread a lot of noise in media. 'Stock market is dead' they yell and pick bottoms, 'Oil goes to $500!' they promise while selling market at the top. Examples are numerous. Should you listen to them? Probably, if you see that their buying/selling spree has just begun. However, if you see that funds are super long gold and keep forecasting prices 10 times higher - you better be careful. So here we have an opposite type of behavior and investment strategy - when speculators are very long (short) expect prices to drop (rise) in coming future as they need to fix their profit.

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There is another group but we suggest to exclude them from your analysis - swap dealers. Originally, when COT was released there were only 2 groups - commercial users and speculators. But after some time speculators were split into managed money and other speculators and commercials were split into producers and swap dealers. Must be a reason for that. If you do your research you will see that swap dealers are mostly banks - Goldman, JP Morgan, HSBC, Citi etc. They are not the users. They may be agents for the users but they may be agents for other banks or funds as well. Important is - their core business is finance not agriculture or mining. They do not have the best inside knowledge. This is the reason why we do not look at them - it is hard to understand their motivation, whether they come to hedge or to speculate.

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Last group of players is small traders. We also exclude them from our analysis - small is small, nothing they can do to move the markets.