WTI historical chart adjusted to inflation (1946- dec 2016)
The goal of this post is to tackle different aspects I find important when it comes to oil trading. What traders or investors should know and what indicators to use when trading crude oil?
- (1) A multi-factor approach
- (2) Observations about oil
- (3) Oil Investing basic approach
- (4) My personal way of placing a trade
- (5) Examples
(1) A multi-factor approach
Oil is wonderful for the generalist trader. Depending on your investment horizon, you have to weight different elements and signals before taking a decision, as for me it generally goes this way:
- Short-term: importance of chart analysis / technicals
On the short-term oil is a very volatile asset. But there are strong and “respected” indicators that can sometimes help. I often use technical analysis in a ranging market or “slow” day, without any important news or data release.
What I use the most: support & resistance, Bollinger bands, RSI
Ex in this trade, indicators where showing overbought conditions, and it turned out to be profitable: 13.12.2016 – OPEC Deal fallouts: Short Trading Opportunity
- Medium-term main risk: geopolitics
Major risk when trading on a week or month horizon is that unexpected event happens in the world.
I.e: war in Middle East, riots in Saoudi Arabia, sabotage in Nigeria, Trump tweets
On the long-term fundamentals tend to keep things balance and if there are no huge change in amount of supply/demand linked to the peculiar event the price action has time to mean-revert.
On the short-term the risk is lower (day trading, scalping). But always there
- Long-term trend: Fundamentals
Commodities investing is all about demand and supply on the long-term. Why did we recently experienced a 70% drop? US Shale oil disrupted the fragile balance in the oil market.
Great movements on oil prices always come down to fundamentals, and this is where real money is made.
What makes oil market tricky is that you have to take into account expectations which are very volatile (related to OPEC cuts for instance at the moment)
- The importance of the US Dollar
Oil is traded in dollar. As a result, it is inversely correlated to this currency.
This inverse correlation is especially clear when there is a long-term trend. In 2003 – 2008 the dollar was in a sustained bear trend while crude oil witnessed one of its strongest bull runs. Then the trend changed direction at the same moment during the financial crisis: rally in dollar and fall in oil.
Yet on the short and medium term this correlation may not always hold. The context and/or other news may drive oil prices regardless of the direction of the dollar.
(2) Observations about oil
- Seasonality (US)
Spring: usually lower demand. Indeed refineries schedule their repairs during this period, roughly 25% close
In May the maintenance season ends -> refinery oil process increases -> stock level decreases -> price increases
Brent (€) chart. 2001-dec 2016
Green arrows: the beginning of the summer. Usually a period of higher oil prices. Summer is the “driving season” in the US. As a result there is more demand and so more pressure on stock and prices usually encounter more upside momentum.
- Decay in Producer Data / Production Data / Price of oil
In the US for instance, we have been assisting to a fall in oil rigs in 2015 , yet the production began to fall in the second semester of the year. There is a latency period to take into account
- Oil loves Great Movements
Oil has been historically prone to impressive upside/downside move
For instance, over the past 30 years (except for current), oil has experienced 6 big lows, and all were in V-shape (see first graph).
(3) Oil Investing basic approach
- Technicals on the short-term
Look for: trading range, support and resistance on the short-term
- Consider fundamentals on the long-term
On the long-term Even if you identify a strong technical signal, a fundamental signal will have the upper-hand.
- When to expect volatility: fundamental data such as production, rig counts or inventories data
Check my: Economic Calendar for Oil Traders
Volume usually increase a lot around those release. Hard to trade and can break a trend.
Usually main drivers of the prices.
- Sentiment: Commitment of Traders report
To see open interest in oil futures. Good indication of market sentiment.
Sometimes really useful when adopting a contrarian approach.
See: Sentiment Analysis – Why the Huge Bullish Positions of Hedged Funds and Money Managers could Spark a Correction. Before a -12% correction
- Geopolitics: the x factor
OPEC meetings, Russia, Iran sanction-related meeting, Trump declarations…
(4) My personal way of placing a trade
What I do when placing a trade:
- Check the daily chart to see the long-term trend
I check the current trend in fundamentals data (production, inventories, rigs)
- Check the 10 min chart to look for a good entry point
I look a technical indicators, mainly Bollinger, pivot point, support & resistance and RSI
- Check the news & calendar to see what is currently driving the market and what will probably drive the market in the near future
(5) Example of how I think about a trade