(1) First are the commodity producers. Analysts call them the "smart money." Also known as commercial hedgers or just "the commercials," they are seen as the folks with the best market information. When they are increasing their positions in crude oil, for example, it's probably a good time to get some energy stocks. These traders are involved in the day-to-day operations of each commodity. They have an excellent handle on the underlying market, and it typically pays to follow their positions when they reach an extreme.
(2) Then there is the dumb money - the "non-commercial" category. These are the large speculative investment funds and large hedge funds, usually called the "large speculators" or simply the "large specs" - or just the "dumb money." They are primarily trend-followers, and will accumulate positions as a trend progresses. Analysts say they are usually wrong at market extremes. If they are buying oil, it's probably a good time to sell your energy stocks. When their positions reach an extreme, watch for a price reversal in the opposite direction of the existing trend.
(3) The third group is the "non-reportable" category. These are smaller traders, composed mostly of hedge funds and individual traders. These guys are seen as the really dumb money. They are the small-time traders who apparently don't know what they're doing at all and don't provide any meaningful market information. Or so say most analysts.
In essence, speculators (“dumb money”) are trend followers while commercial hedgers are contrarian. Speculators like to trade with the prevailing market trend while commercial hedgers like to trade against the prevailing market trend.
Note: the COT Report is a useful sentiment indicator for the commodities and forex markets. It is not useful for the stock market. There is no group of market players (Speculators vs. Commercial Hedgers) that’s consistently better at timing the stock market.
See the Commitments of Traders Explanatory Notes |
Keep in mind the commercials are sometimes not right. They are not in the market to time market turns; they are hedging their risk exposure in a cash position. Therefore the non-commercials, professional speculators, and funds, in the short term, are considered the "smart money." Here are some general guidelines to follow:
- If non-commercials are net long, commercials are net long, and the non-reportable positions category are net short by at least a two to one margin, look at buying opportunities. In other words go long with the pros.
- If non-commercials are net short, commercials are net short, and the non-reportable positions category are net long by at least two to one margin, look at selling opportunities.
- If non-commercials are net long, commercials are net short, and the non-reportable positions category arc neutral, meaning not heavily net long or short, look at buying opportunities, and stick with the non-commercial "smart money."