How to Read and Understand the COT Report

What's next now that we've find out how to identify sentiment extremes？

Keep in mind that not every extreme of feeling corresponds to a market top or bottom, thus we'll need a more specific sign.

Calculating the percentage of long or short speculative positions would be a better indicator of whether the market is topping or bottoming out.

The formula for calculating percent -long and percent -short is as follows:

Let's look at what happened with Canadian dollar futures a few years ago to further understand this.

Speculators were net short 28,085 contracts according to COT statistics for the week ending August 22, 2008.

They were net short 23,950 contracts on March 20, 2009.

On the basis of this data, you may conclude that a market bottom is more possible in August because there were more speculators short at that time.

But wait. You didn't think it'd be that simple, did you？

A closer investigations reveals that 66,726 contracts were short, while 38,641 were long. In August, 63.3 percent of all speculative positions (66,726 / (38,641 + 66,726) were short positions.

In March, though, there were only 8,715 long contracts and 32,665 short contracts.

This suggests that all over that time period, 78.9% of the speculative positions were short (32,655 / (8,715 + 32,665). What exactly does this suggests？

When 78.9% of all speculative positions are short, a bottom is more possible to occur than when only 63.3 percent are short.

As you can see from the graph above, the bottom did not happen in August 2008, when the Canadian dollar was valued around 94 cents US.

Over the next few months, the Canadian dollar continued to plummet.

The Canadian dollar had struck a low around 77 U.S. cents by the time March rolled around and the percent-short ratio touched 78.9%.

So, what happened next？ It began to increase steadily!

Is this the bottom of the market？ Yes, you've found out!