Extreme Short Positioning on the USD from Non-Commercial Accounts

The Commodity Futures and Trading Commission (CFTC) publishes the Commitment of Traders (COT) report descriptions revealing investors positioning in various financial assets. Based on position data supplied by reporting firms, the reports are closely watched, especially for those with interest in the currency market.

As the FX volume of one broker does not reflect the entire volume of the FX market, it is difficult to interpret the positioning on the currency market. As a side note, this is one of the reasons why Volume Spread Analysis (VSA), a powerful trading theory in the stock market, does not quite work in the currency market.

A recent CFTC report referring to the Dollar Index (DXY) reflects the largest non-commercial dollar index position in the last seven years. How to interpret it?

Interpreting the CFTC Non-Commercial Reports

First, we need to define what the DXY is. As an index, it reflects the USD evolution against a basket of currencies, each having a different weight: EUR (57.6%), JPY (13.6%), Pound Sterling (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and the Swiss Franc (3.6%). The value of the DXY is the weighted geometric mean of the value of the dollar against these currencies.

Second, we need to understand how the CFTC classifies non-commercial traders. According to its rules, a non-commercial trader is one that does not take delivery of the futures contract and has no other interest but to speculate on the market’s move. This category includes not only individual investors but also large financial institutions and hedge funds.

Coming back to the recent report showing extreme positioning on the short side of the DXY for non-commercial traders, the signal is a bearish one. These are not only retail traders that usually are on the wrong side of the market – but professional traders and investors with access to more resources and better research to back their views.

So, is the DXY doomed? It may be so, but the trick is to look at its composition and figure out what can cause such a decline in the DXY? The easiest answer is for the EURUSD to keep rising. Because the Euro is more than half of the DXY’s weight, a strong bullish trend there would explain the non-commercial positioning.

But it could be that it is not the EURUSD, and it is the USDJPY declining more. Or the GBPUSD rising aggressively.

All in all, the signal may be bearish on the USD, but there is still plenty of due diligence to find the right horse to ride it.

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