As mentioned in the previous article, the tendency of the speculators is to add long positions in a bullish trend (or short in a bearish trend) to create a "bullish / bearish extreme sentiment" situation.
The rules to catch the moments of extreme sentiment are basically three:
- - Speculators and commercials are always on the opposite side of the market;
- - Speculators are almost always on the right side of the market except during the trend reversal, where they are caught unprepared because unbalanced in the same direction;
- - Commercials are always on the wrong side of the market except during the trend reversal when their continuing mediation activity of the price leads to the creation of positions that gradually return to profit;
Let's see some concrete examples concerning how to operate successfully in the Forex with information coming from the Cot FX.
The chart here below shows the net positions of EURUSD held by commercials and non commercials. As we can see, when the differences between the two participants reach extreme values, it is likely that this advances the primary reversal points of the market trend.
Commercial and Non-commercial Euro FX Net Position
The next graph shows at the top the weekly bars price concerning EURUSD. In the central part of the graph, in blue, the balance between the weekly long and short positions of the speculators, extracted from the Cot report. The black dotted line that moves between the blue histogram represents the percentage of net long or net short compared to the open interest.
This indicator is far more important than the net balance, since it represents, in percentage terms, how much the speculators are unbalanced from the long or short side compared to the volumes; the higher (if they are net long) or lower (if they are net short) this percentage is, the more the sentiment is excessive and at risk of reversal. Let’s check the last three primary lows of EURUSD, the 2008, 2010 and 2012 ones. The net short positioning has been a common denominator for all three cases, but it is not the same for its value. However, if we connect this absolute net short value of the Euro on the open interest, then we immediately notice that in all three cases, we have fallen below 25%, a first alarm bell that some strong excesses of pessimism were registered on the sentiment side and that the opening of short positions on EURUSD was becoming very dangerous.
EURUSD Long-Short
Here is another recent case. USDMXN has recently experienced a sharp depreciation and this has obviously been accorded with the hedge funds. However in October, the net long reached the absolute top, but most of all, the ratio of this value with the open interest exceeded 60%, a clear excess of positive sentiment in favor of MXN. When the net long and the percentage on the open interest in the past have exceeded well-defined levels (see the horizontal red line), the bottom of the primary market was almost in sight. The beauty of this strategy is that we can also use it in the opposite scenario. USDMXN is in fact a cross for sale when the speculators become simultaneously net short on MXN with a percentage of the open interest lower than -10%.
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