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Unlike the OTC data that is currently available, there are two major advantages with data from open outcry exchanges — it is available relatively quickly after the trade is made and it is transparent. The rules of the exchange concerned require not only full documentation for each trade, but also the type of account making the trade. The weekly IMM Commitments of Traders report collates trades made in currency futures contracts through the IMM trading pit in Chicago by various types of accounts. For our purposes, the most useful type of account that we are interested in is what the IMM euphemistically calls “non-commercial accounts”. In layman’s terms, this means speculators or accounts that trade currencies on their own with no attached underlying asset.
Granted, the volumes that go through the IMM currency futures’ contracts pale by comparison with the regular interbank market. However, here again, the advantage is that the IMM data is transparent. Moreover, given that the non-commercial account trades represent the activity of the speculative community on the IMM, this can be used as a reflection of overall speculative activity in those currencies. Indeed, one can go further and say that precisely because IMM volumes are small relative to the interbank market, a notable speculative position in a currency pair on the IMM may actually be reflective of a similar but much larger position in the interbank market. Before going on further, it is probably useful to take a look at an actual IMM Commitments of Traders report and seek to analyse it, just as a currency analyst would for their traders and clients.
As the data shows, this report reflects the total long and short open positions that IMM speculators have in these currencies at any one time (in this case as of November 20, 2001). This is very useful information. If a speculative position becomes too large, we know from our work looking at the speculative cycle that it may eventually be reversed. Thus, using this information, traders, investors or corporations can position accordingly to anticipate such a reversal. In addition, it is a relatively simple matter to graph this against the spot exchange rate. If we accept that the speculative community’s open position in IMM currency futures is a rough reflection of what it might be in the much larger interbank market, this might well give us a much more useful picture of what are the outstanding positions in the market, and thus the outstanding risk and vulnerability.
From this data, we can extract a variety of specifically useful information. For a start, we can compare the net speculative position of the week being analysed to the previous one. In addition, we can compare this figure with multi-year highs and lows. Moreover, if we overlay this data with the actual spot rate, we can see how net changes in the IMM speculative position for each exchange rate correlate with the actual price action. To be sure, the IMM data is not a perfect representation of what goes on in the currency market as a whole, as its volumes are small on a relative basis and IMM-based speculators are not necessarily the same ones that operate in the larger currency market context. That said, the fact that one can use IMM data to generate excess returns suggests that the strong correlation, albeit with a lag, between the IMM data and the actual exchange rate price action does indeed reflect a predictive capacity of the data itself. A large number of banks now regularly use the IMM Commitments of Traders report, both as an analytical and a predictive tool for their own trading desks and for their clients. For example, if we look at the available data we see that the speculative community has built up a substantial short yen position (against the US dollar). The base currency for the IMM data is always the dollar, thus if they were short yen futures, that means they were short yen against the dollar. IMM net positions can of course be easily graphed, either on their own or perhaps more usefully against the dollar–yen exchange rate. If we do that, we see that speculators had in fact been substantially long yen futures for October and much of November. This is also useful to know as it suggests that a potentially important trend reversal has just happened. If we consider this as a reflection in the overall currency market, we get a picture of speculators having been substantially short dollar–yen (i.e. long yen) and of that speculative short position having been gradually eliminated initially and then increasingly reversed. This actually occurred in line with a move higher in the dollar–yen exchange rate, as one might expect as a result of the buying required to close out those short positions. One thing that can be noticed from this example is confirmation that the IMM speculative position was indeed reflective of a much larger outstanding position in the overall currency market. After all, if that were not true, the closing out of the IMM position would have had no effect whatsoever on the price action. You might think this coincidence, but the correlation between changes in IMM speculative positions and short-term moves in the spot exchange rate is too high to be that. While the reversal in the IMM speculative position in the yen may be a notable change and thus may last for some time, there is a further point to be made, namely that the larger the speculative position becomes, the more vulnerable it in turn becomes to reversal and retracement. Indeed, this is entirely in line with the conclusions of our speculative cycle model, which suggests that the longer a currency price trend lasts, the more speculative it becomes and the more vulnerable to a sharp and violent reversal. In line with this, the larger the outstanding speculative position, the more laboured the price action becomes in favour of the prevailing trend. This is not to say the prevailing trend cannot continue for some time. It is to say however that the momentum of that trend will continue to slow as the size of the outstanding position in favour of that trend increases. It is also to say the longer the trend lasts, the more explosive the eventual reversal.
Returning to our IMM example, looking at the dollar–yen exchange rate, the IMM data tells us that speculators were at the time becoming increasingly bullish on the dollar vs. the yen. Here, it helps to add some fundamental explanation to the available flow information. It is a key theme of this blog that analytical disciplines, which focus on the currency market, are best used in combination rather than in isolation. That way they give a much more powerful — and therefore potentially profitable — signal. In this example, the Japanese authorities, in the form of both the Bank of Japan and the Ministry of Finance, had signalled that they were in favour of a weaker yen, in line with the weak Japanese economic picture. The ability of either monetary or fiscal policy to be eased further had been all but eliminated. The only lever left for further policy easing was the yen itself. This idea caught on within the speculative community, with the result that speculators closed out their short dollar–yen positions and created an increasingly large long dollar–yen position, as reflected by the IMM data. As an analyst or as a currency market practitioner such as a corporation or an investor, one can use this information in the following ways:
Analyst — Review the flow and fundamental economic data to come up with an overall picture of the short-term flow and fundamental dynamics in the dollar–yen exchange rate and thus the ability or not of the prevailing trend to continue.
Trader — As the prevailing trend continues and increases in the dollar–yen exchange rate, position to take advantage of the reversal when it comes.
Investor — Use the combination of flow and fundamental data as a guide in determining yen exposure and hedging policy with regard to that exposure.
Corporation — Use the combination of flow and fundamental data as a guide for short-term hedging policy.
To reinforce the point of the usefulness of this data, let’s quickly look at another example. If we look at the position in Euro futures, we see that the net position as of November was net short −286 contracts. On the face of it this may suggest that there is no directional bias for the Euro–dollar exchange rate near term. However, it is important to note that the speculative community had a net long Euro position in the IMM futures contract for much of August through mid-November. Indeed, the Five-year high for Euro longs was hit on August 28 at 31,666 contracts. Since then, there was a gradual reduction in the speculative long position in Euro futures. In line with this, spot Euro–dollar came under increasing selling pressure. Thus, noting that there was such a large net long Euro position at the end of August, one could have positioned to anticipate a retracement in spot Euro–dollar in anticipation of those positions being closed out. Equally, the fact that this net long Euro position switched to a small net short conversely gave the Euro-dollar exchange rate some support as this overhang of long positions had thus been eliminated.