"Tops and bottoms are key levels in a price chart. This indicates that price has completed its trend and reached a top (and a bottom). When a top is formed, it infers that the previous uptrend is nearing its completion, or at the very least, price is due for a correction. Similarly, when a bottom is formed, it indicates that price is nearing the end of its downtrend and is either likely to change direction or will post a correction before the downtrend resumes again. In technical analysis, traders make use of various technical indicators such as moving averages and so on in order to understand the change of trend. Being able to catch a top or a bottom can be lucrative as it gives you an early positioning into the markets. This gives you a lot of time to stay within the trend and be able to make big profits. While it is risky to trade tops and bottoms, the CoT report gives traders a view of when these levels are formed."
Picking tops and bottoms is something many traders dream of. After all, what better place to trade when a trend is just starting to form? It gives you the advantage of being able to take a early position in the markets.
This allows traders to ride out the trend and in the process be able to make big profits. Ironically, it should be noted that one of the rules of money and risk management is that traders should not attempt to catch tops and bottoms.
This is because, as a trend emerges, it is difficult to predict with 100% accuracy if indeed a top or a bottom has been formed. In hindsight, it is easy to see the tops and bottoms, Typically, you will come across divergences, or price reaching a key resistance or support area and reversing.
Depending on the timeframe, you might also find value in knowing that tops and bottoms are often formed where you will notice reversal candlestick patterns as well. There is no doubt that traders have their own ways of calling tops and bottoms.
Among these different methods, the CoT report can be a useful tool. Mind you that we say that the CoT report is a valuable tool. It is by no means a fool proof method of trading. Rather it is merely a tool that can help you to identify the tops and bottoms.
Because the CoT report comes out weekly, it can be used as a market sentiment indicator. This is more suitable for long term trading such as swing trading.
By this point, you might be asking the question as to how you can use the rather complex data from the CoT report into identifying potential tops and bottoms in the markets.
This is achieved by simply looking at the open interest, net long or net short positions. Typically, when market positioning is extreme, that is where you will find the tops and bottoms taking place. Once again, we should warn that the tops and bottoms are only indicative.
There are many instances where you will find that despite the extreme positioning in the markets, price will continue to maintain the previous trend. Thus, if you enter the position a bit too early, there is a good chance that you will be caught out with a stop loss.
You should always use the CoT report alongside other technical indicators that can validate your view.
Let’s illustrate this with the chart below. You are looking at the Australian dollar futures. In retail forex, this would translate to the AUDUSD currency pair.
Australian dollar futures – CoT Report
In the above chart, you can see the top part showing the price chart for the AUD currency (against the U.S. dollar).
On the lower part of the screen is the CoT position data for the different categories. Note that we are primarily interested in the non-commercial position. The question to ask is, what are large hedge funds and money managers thinking.
Around September 2017, the non-commercials continued to build up their positions. It led to a point where the non-commercial positioning reached an extreme. In other words, the institutional money was bullish on the Australian dollar.
Evidently, this leads to an increase in the price of the Australian dollar. This coincides with the top being formed. Following this extreme position, as the speculators or non-commercials start to unfold their positions, you notice how the AUD starts to decline in value again.
This is nothing but the top being formed. However, if you observe carefully, you will see that the top formed resulted in a reversal, but only a correction. At that time, it would be difficult for you to tell if the top was indeed a top of a rally or not.
Looking at the chart further, you can see that price formed a low but quickly snapped back and rallied to the previous highs. At this point, the highs in the price did not coincide with the extreme position on the non-commercial (or even the commercial) side of the report.
Following the chart, what we currently see, since September 2018 is that commercials are starting to build a net long position. As a result, you can see that price has been forming a somewhat flat bottom. This indicates that currently a bottom is taking shape in the Australian dollar markets.
Once you have a fair idea of what the markets are doing the next step is to simply apply other aspects of technical analysis to further fine tune to the levels where you think a reversal is going to take place.
