Why it pays to follow the leader…

Why it pays to follow the leader…

In every wolf pack, you have an alpha.

The alpha is the leader, the one who guides and keeps control of the rest of the pack

The rest of the pack is actually just the wolf’s offspring and sometimes the weak offspring die…

Let’s consider this for a second… why would the weak offspring die?

My bet is that they stop following the strong leader and get caught out in a cold winter, or get hunted down by another pack…

The markets operate in pretty much the same way…

We are the offspring in this game and the big banks, hedge funds, and people with multi million pound accounts are the alpha wolves.

They are the hunters who are able to push the market around… start new trends… take us out and have more liquidity for their larger orders.

So what can we do to identify which way the larger players want to send the market?

Well… there’s a little thing known as the Commitment of Trader’s Report (COT) that is released by the Commodity Futures Trading Commission (CFTC) – a US regulator – every Tuesday.

The Commitment of Trader’s Report displays the changing positions of market participants on US futures exchanges. You can view the latest report here.

However, deciphering that report can be an absolute headache. It’s used more as just a data source than anything to take information from.

I much prefer looking at the report as a chart – see the chart below for the Euro FX (Euro futures):

Click image to enlarge. Source: barchart.com

Let me explain this chart to you…

The line we want to focus on is the green one in the bottom section of the chart.

This shows the positioning of the large speculators. These are the guys that drive the trends that we see in the markets.

Note that they work in opposite to the red line…

The red line shows us commercial speculators. These are the firms that are hedging their business activities. This might be Apple, Amazon, Tesla or Tesco, for example.

When the market is rising, they may seek to hedge any Euro denominated currency risk and so they sell futures when the market is rising, and buy futures when the market is falling.

Therefore, the large speculators (green line) buy when these guys are selling, and sell when these guys are buying.

Take a look back at the chart and note the horizontal and vertical black lines I’ve drawn on…

When the green line started rising (and the speculators started closing their short positions), the price started to rise.

When we reached 1.14, the speculators flipped their bias to net long Euro. That is when we had the breakout above 1.14 and the rally up to 1.20.

You can clearly see that looking at COT data is a very handy way to see where the market wants to go…

Here’s another example for you – have a look at the following charts showing Gold and the AUD.

Click image to enlarge. Source: barchart.com

Click image to enlarge. Source: barchart.com

Now, before I explain what you can see in those charts, let me firstly tell you about the correlation between Gold and the Aussie Dollar…

Australia produces a hell of an amount of gold. This means that there is a flow of money between mining firms and the firms that buy gold to produce goods to sell to consumers.

Therefore, it is only right that the Australian dollar would follow gold demand.

Now, take a look at the green line on both charts again (positioning of the large speculators). Note that both increased in long positioning at the same time.

(For the Gold chart, the red line is producers – they will always be selling to demand which is why producers cannot turn net long and speculators cannot turn net short).

Remember, COT positioning helps for longer-term position traders.

But it can also help us with deciding when a trend is going to change as well…

Take a look back at the Gold chart above. Note the extreme positioning of the red and green lines. They are currently at the same extreme levels of the past three years.

Now a look at the price action, which is slightly easier to view in the chart below:

Click image to enlarge. Source: tradingview.com

This is very bearish. There is a wick to the upside, but a bearish candle that shows absolutely no buyers on the weekly open (there is no wick up on the red candle).

If we combine that with our extreme net positioning on Gold, we can see that there is a case to be made to remain short to the next support level at $1293.

Using the trend clues made by the bigger players can really help boost your trading…

And remember: never try to fight them, since they will make you the beta of the pack.