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COT analysis and the EUR/USD

 

I have downloaded a EUR/USD chart overlaid with COT readings from an excellent analysis website on the subject at upperman.com, which shows that the indicator has worked reasonably well at highlighting trend exhaustion on long-term charts over a 5-year period.

Generally the indicator is used to by looking for extreme divergences between the positions of the large speculators or “Funds” and “Commercials” who hedge. However, another possible use could be to generate signals by overlaying price and Net Positions as in the chart below and looking for cross-overs, in the way that signals are generated from long-term moving averages.

 

FX prices COT analysis

The chart above shows an example using EUR/USD; first look at the way the “Funds” line – the blue line indicating the positions of the large speculators interacts with price. It tends to pick tops and bottoms very well – which is not unsurprising given we they are the positions of hedge funds and professional speculators.

Following the lines we see that the Net Fund’s COT position first crosses down through price in Jan ’08 about three-quarters of the way up the rally which ended in August with a crash. Next it turns up through price in Sep ’08, again about three-quarters of the way down the bear market. There was some unclear whipsawing with price during the summer of ’09 before a clear cross-over in Nov ’09 not far from the top of the market. Finally in May ’10 it neatly picks the bottom of the market. Right now it is a little unclear whether it is crossing down through price, indicating a top has been reached or not, but it may well be the case.

On the chart below I have highlighted these cross-overs. They could be used as early warning indicators of a trend change, with a 1-2 month lag.

COT analysis 5 year period

They could also be used as part of a trading system with cross-over’s indicating positions should be liquidated.

Research by:
Joaquin Monfort
Forex4you Analyst