The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.By Scott Pluschau NEW YORK ( ETF Digest) -- Last week I wrote an article on the Legacy Commitments of Traders Report (COT) in the Dollar Index. This index is based on the performance of the dollar relative to a basket of foreign currencies. However this is a weighted basket, with the euro having on overwhelmingly large weighting of nearly 60%. The other currencies in the basket are the yen, pound, Canadian dollar, krona and Swiss franc. So what happens to the euro is going to have a major impact on the performance of the dollar index. It is for this reason that some have requested I provide commentary on the euro futures. This past Friday saw the release of the most recent COT reports. The COT reports are put out weekly by the United States Commodity Futures Trading Commission. Without a holiday to interfere, the CFTC releases the reports for all futures contracts at 3:30 p.m. ET on Friday of each week, for which the cutoff for the report is the Tuesday of that week. The report this past Friday was for the cutoff on Tuesday, Jan. 17. The legacy COT report is broken down into two categories, the "Reportable" and the "Non-Reportable." What determines whether you are a reportable or a non-reportable depends on the specific futures contract and the size of the position you are holding. If you are above that size, your positions must be reported to the CFTC. Every position that is left over from the reportable category in the current open interest is put into the non-reportable category. Each digit of open interest is a single contract between a buyer (long) and a seller (short). If you are a non-reportable, you are likely a "small speculator." The reportable category is broken down between Commercial Traders and Non-Commercial traders. Commercial traders use futures to "transfer risk." They are known as "hedgers." An example of a commercial might be someone who is selling an enormous amount of goods or services overseas between America and Europe to be delivered and paid for at a future date in time in either euro or dollars.
Well if you have a deal today and the euro gains or drops significantly in value between when you made the deal and when you actually got paid, it could affect your profits or losses in the business. A commercial would offset this risk by using the futures markets to lock in his profits on that business transaction. A commercial must prove to the CFTC their need to use the futures markets to hedge. The commercials are considered "informed money" because nobody should know more about the fundamentals of their business than they. When they are heavily invested on one side of the open they believe a move has gone too far and is either severely overvalued or undervalued from fundamental perspective. It is a major warning to the smart speculator that the trend may be ending. Some speculators will have a strategy to capitalize on a "reversion to the mean." The non-commercial in the reportable category is a "large speculator" who provides liquidity and fair pricing in the futures markets by "accepting risk" to make a profit. A hedge fund would be a type of non-commercial. With that being said, this week the commercial traders (hedgers) went long the euro 6,489 contracts and short 966. The large speculators reduced their long position 1,374 contracts and increased their short position 3,461 contracts. The small speculators increased their short positions 2,042 contracts and increased their long position 1,354 contracts. It is quite obvious that the speculators are looking for the downward trend to continue in the euro. What is significant to note in this report is that the euro made a new 52-week low on Friday, Jan. 13, a date which would be included in this report. The commercial hedgers are now long 238,254 contracts and short 51,069 for a net long position of 187,185. It doesn't look to me like the commercials are afraid of the euro collapsing. If your business depends on it, you would think they would be hedging by selling the euro and buying dollars. This is quite the red flag, in my opinion. This is something to keep an eye on in the coming weeks. The euro exchange-traded fund is known as Euro Shares ( FXE). Let's take a look at its chart.
After an island reversal in October 2011, it was all downhill for the euro. An island reversal is when a market gaps up and then within a few days gaps down, leaving an island all by itself on the chart. This is a very bearish pricing pattern. Lately there has been a MACD crossover and the relative strength index is showing a bullish positive divergence by making new highs. Without a major reversal pattern developing, I don't see any reason to justify a trade in the euro at this time with my trading system. Should the euro ever get back above $145 I will certainly be looking to buy. Why would I be looking to pay $145 when I can pay less than $130 today? Because it may never get to $145, and even worse, it may go down to $85. The greatest probability for me to make money buying euros will be when the path of least resistance is higher. Should the commercials start to unwind their long positions and go short, I would be favoring short trades. Dave Fry did an excellent article on the Top Ten Established Currency ETFs back in December 2011. Subscribers to ETFDigest get email alerts for trades being placed in the model portfolios. -- Follow this writer on Twitter/ScottPluschau Comments are welcome at Scott.Pluschau@etfdigest.com.