In a nutshell, analyzing any one CoT report in isolation is pointless. It is crucial to know not if commercials or speculators are net long or net short, but rather how extreme their position is relative to the past. I use percentiles to give context to the current net positioning number.
For example, consider the position of commercial traders in corn over the past five years. If their most bullish position had been net short 12,363 contracts, and their most bearish position had been net short 555,715 contracts, then the current net CoT position of net short 426,928 contracts would translate to a five-year percentile of 24%. A percentile of 0% would have mean that commercials are more net short than they’ve ever been in the past five years.
While creating a percentile to give context to net positioning is a step forward, it’s still a flawed approach for one reason: you have to account for markets growing and shrinking over time. In the above example, what if when commercials had their huge net short position of 555,715 contracts the open interest in corn futures was 2,088,225 contracts? Now, the market is smaller since the open interest is only 1,707,744. So the current net short position of 426,928 is “bigger” relative to the total size of the market than it would have been when open interest was +20% higher.
The solution is simple. Rather than calculating percentiles solely based on net position numbers, I calculate percentiles based on net position numbers as a percentage of open interest. Using the exact same data from above, here’s the data adjusted for OI:
Most Bullish Position: -12,363 contracts on 11/1/2013 (when OI was 1,902,900) = -0.65%
Most Bearish Position: -450,253 contracts on 6/17/2016 (when OI was 1,531,416) = -29.40%
Current Position: -426,928 contracts on 3/10/2017 (when OI was 1,707,744) = -24.99%
Using the above three numbers, the 5-year percentile is now 15%. This is much less than the previous reading of 24%. Why? Because open interest in corn has decreased and the current net short position of -426,928 is bigger relative to the size of the market than it would have been a few years ago. Let’s dive into what this metric looks like.