In the February issue of ForTrader.org, I talked about the ability to track the mood of the futures and options markets in graphical form. However, determining peaks and troughs on a chart by eye is a thankless task. First, it is difficult, and second, there is the risk that you will only see what you want or vice versa. In order to solve these problems and, in particular, to reduce the influence of subjective opinion on decision-making, you can standardize the values of the positions of market participants.To standardize the various data that are contained in traders' reports SOT (Commitments of traders report)The SOT is based on a variety of indicators. However, most of them are based on the "fast stochastic" formula (I remind you that you can download SOT reports from the Commodity Futures Trading Commission (CFTC) website www. cftc. gov).
COT index (Commitments of traders report)
The first indicator I will pay attention to is the classic market analysis indicator SOT Index by Larry Williams, the guru of short-term and medium-term trading.
SOT indices allow you to quickly and efficiently assess the market situation. In contrast to the values of net long positions (aggregate positions), the SOT index clearly shows which level of aggregate positions to consider high and which to consider low.
The calculation of the index is quite simple. As I mentioned earlier, it is based on a stochastic oscillator.
- The value of the current week is the value of cumulative positions for this week.
- Minimum and maximum - the minimum and maximum values of the cumulative positions for the last n weeks.
The formula of total positions (net long positions):
Net positions (net long positions),=long positions, - short positions,
Aggregate positions are found by calculating the delta between long and short positions of a particular group of market participants. That is, there are a total of three SOT indices for each group:
1. the SOT index: hedgers (operators) - [commercial].
2. SOT index: large speculators (funds) - [non-commercial].
3. SOT index: small traders (small speculators) - [nonreportable positions].
The SOT index compares the current value of aggregate positions with the maximum and minimum values for n weeks. The index is expressed as a percentage, and the index values are always in the range from 0% to 100%. 0% corresponds to the minimum value of aggregate positions, and 100% to the maximum value of aggregate positions for n weeks.
Calculation of the SOT index as an example
For more understanding, I will give an example of calculating the SOT index for operators (hedgers). The comparison period of aggregate positions in the index is 12 weeks (quarter /3 months).
The meaning of the current week 700
Minimum value for the last 12 weeks 500
Maximum value for the last 12 weeks 1000
SOT index: operators = (700-500)*100/(1000-500) = 40%
This means that hedgers are currently away from both minimum and maximum critical values. Critical because they are record highs.
Graphical representation of the SOT index
Let's look at the SOT indices of all three groups of participants in the cotton market. The period of the indicators is 78 weeks, although a shorter period is used in trading. I chose the 78-week chart, because it is smoother, otherwise a person unfamiliar with these indicators will be difficult to understand.
Just before a strong rise or fall in price, market participants increased their long or short positions, resulting in their combined positions reaching record sizes. At SOT index this was reflected as a change in values to close to the limits of the range - 0% and 100%.
Not all indicator "signals" are correct. Like any other market indicator, the SOT index sometimes wrong. Sometimes the signal appears long before the trend changes itself, so you have to be patient and use technical support in market analysis.
What is the critical value of the SOT indices?
According to Larry Williams, if the SOT index value is 75% or 25%, it buy signal/sale depending on the group of market participants for which the index is calculated. If you read the previous articles, you know that when hedgers buy, speculators sell. At the same time, another pro of trading based on the positions of market participants, Steve Breeze considers critical values equal to 10% and 90%. So "jump" around 20% and 80%, plus/minus 5% and see which option you like best, experiment.
So how do you work on SOT indices?
The interpretation of SOT indices, as well as any other fundamental or technical data, is not simple and requires some experience and time. However, in a simplified form the following table can be derived:
What period to use for comparison?
Larry Williams suggested using periods of 1 to 3 years. At the same time, Steve Breese uses a period of 13 weeks. Personally, I use a period of 52-78 weeks and am going to reduce it to 26 weeks. The main thing you should understand is that you can choose your own period for trading. Just keep in mind that the longer the period, the less frequent the signals will be. The reason for the shorter time frame is that the markets are becoming more volatile every year. And it is no longer necessary to expect really big changes in positions on a multi-year scale in order to catch a big price change.
I will end this article here. I wish you diligence, patience, and as a reward, successful trading.