Creating Your Own COT-Based Indicator

Did you ever want to have an advantage that goes above and beyond raw charts and indicators? Most traders operate using the same sameness, using the same moving averages, oscillators, and price action setups. But what if you could create an indicator of your own that represents the True positioning of traders in the market?

THAT is where a COT-based indicator comes in. Using data from the Commitment of Traders (COT) report, you can create an individual indicator that can demonstrate sentiment shifts, warn you of potential reversals, and offer a new viewpoint of the activity in the market! This article reflects how you may create a COT-based indicator, step-by-step, in a practical manner that is easy to implement.

Understanding the COT Report

Before you create an indicator, you must first have an understanding of the raw material. The COT report is published by the U.S. Commodity Futures Trading Commission (CFTC) every week, presenting a snapshot of how different groups of traders are positioned in the futures markets. Traders are divided into groups of:

- Commercials (Hedgers): Businesses that use the futures market to limit themselves from price swings;

- Non-Commercials (Large Speculators): Hedge funds and big traders bet on the direction of the market;

- Non-Reportables (Small Traders): An ordinary retail participant that holds smaller positions.

This data does not give you an understanding of where the price may go tomorrow. Still, it provides a sense of sentiment extremes (i.e., traders are grossly positioned to one side). Sentiment extremes often demonstrate at market tops and bottoms.

Why Build a COT-Based Indicator?

Reading the COT report in raw table format can truly be overwhelming. Objectively, numbers do not always reflect a story! An indicator can lend a hand in the following manner:

• Visualization of Data: Converts raw positions into more user-friendly charts or oscillators--easier to interpret than raw data.

• Identification of Extremes: Determines when the trader's positions are at extreme historic highs or lows.

• Trends: Determines if sentiment is strengthening, weakening, or diverging from price action.

• Designed to Your Style: You can construct it to fit your style, whether you are a longer-term swing trader, a trader of medium-term trends, or a shorter-term setup trader.

Deciding on the Heart of Your Indicator

When developing your own tool, you ultimately must determine which component of the COT data you wish to incorporate. Some standard options include:

1. Net Positioning

Subtract short positions from long positions for a particular group (e.g., non-commercials). Once you establish this, you can plot it as a line, which can inform you of the degree to which that group is bullish or bearish.

2. COT Index (0–100 Scale)

Compares the current positioning to historic extremes. For instance, if the speculator level is at 95 on the COT index scale, it indicates an extreme bullish sentiment, which usually is a contrarian interpretation.

3. Spread Between Two Groups

This involves analyzing the difference between commercial and non-commercial positions. A widening gap can indicate that pressure is building in one direction.

4. Speed of Change

Measures the speed at which people are changing their positions. A sudden movement up or down usually leads to sudden price action in the market.

Gathering the Data

Once you have determined the level of data required for your indicator, you will need to access historic COT data. You may do this by the following:

• Downloading from the CFTC website directly (it is free, but it is a lot of raw data and user-unfriendly).

• Using third-party data providers, which take the information and arrange it into a more usable format.

• Importing the finished data into Excel, Python, or your trading software if it accepts custom indicators.

Step-wise Guide to Building the Indicator

Here is a streamlined approach:

1. Data in Your Platform

Open the weekly COT figures within Excel, MetaTrader, TradingView or whatever platform you choose that can do custom coding.

2. Select Group & Measurement

Determine whether you will utilize non-commercial net positions, COT index or any other calculation.

3. Normalize the Data

Markets adapt over time. Normalizing the data (such as scaling data from 0 to 100) allows for measuring data over multiple years.

4. Indicator Call-out

Template your line or oscillator underneath the price chart, so can easily see how movements with price action do sentiment lines and/or oscillators work.

5. Thresholds

Label the levels to point out extremes. For example, greater than 80 could mean overbought, while less than 20 could be oversold.

6. Backtest & Optimize

Backtest the indicator on historical data, and see how many times it goes in extremes of sentiment with tops/bottoms. Fine-tune threshold and/or measurement.

Using Your Managed Indicator

Now that you have created it, here are the different ways it can be used:

• Look for Tops: If an indicator shows that speculators are extremely bullish and if your price chart is stretched, it may display exhaustion..

• Look for Bottoms: The extreme bearish sentiment and your price chart, oftentimes, will display a change of direction.

• Divergence Signals: A price chart making new highs, but if the indicator displays a sentiment to weaken, that is a big warning.

• Trend Continuation: A moderate reading that is consistent with price action suggests that the trend is still intact.

Combining with Other Tools

No indicator should be used in isolation. To increase the level of precision:

• Combine your COT indicator with technical levels (support and resistance).

• Combine it with momentum indicators (such as RSI and MACD) for confirmation.

• Leverage the fundamental understanding (central bank policies or data releases) for a check on the signals.

Example in Practice

Let's say that you create a COT index that scales speculative positioning from 0 to 100. Over the last 10 years, every time the index exceeded 90 in the Euro futures market, the price eventually reversed within weeks. In this case, the index would have recently reached 92 while the price is rallying. This gives you compelling reason to watch closely for a top, especially if the technical charts show there is resistance nearby.

Common Mistakes

• Over-Optimizing: Changing your formula to make it fit more with the past is a flaw and will give you a false sense of confidence.

• Over-Look Lag: COT data is weekly and delayed. You are not looking for intraday scalping opportunities, but using COT data for a broader construct.

• Relying on only one group of traders: Watching only speculators may mislead you. Always compare to commercials.

• Not following proper risk management: The best signals do fail. You need to use stops and size your trades.

Best Practices:

• Keep the formula simple, because a more complicated formula does not guarantee better results.

• Always use historical context to gauge what "extreme" means in any market.

• Treat this tool as a sentiment compass, not a crystal ball.

• Keep updating your data.

Conclusion

Creating your own COT-based indicator involves taking raw sentiment data and transforming it into a usable form, rather than devising a complex formula. Even as you go through the process of building your COT-based model, the more you normalize the values and plot them against price reactions, the more you are building a tool that highlights crowd behaviour in ways that standard indicators cannot.

A properly used COT model will help you manage and employ your own decision-making approximately and somewhat systematically in recognizing when markets may be getting stretched, where tops and bottoms may be forming, and sentiment that is supporting or not supporting a trend. Proper use of this with technical and fundamental analysis creates your own unique input, turning numbers into more pragmatic trade expressions.