Last week, almost all components of the major asset classes sold-off sharply, driven lower by the steep drop in crude oil prices. We all know the trend is down in the crude oil market and we all know about the bearish fundamentals. The fact that we are told everyday about the global supply glut, the slowdown in demand in China and the lifting of sanctions in Iran seems to be making traders a little bit too comfortable, in my opinion, about pressing the short-side of the March Crude Oil contract.
identify the markets most correlated with crude oil at this time then prepare to pull the trigger
It’s seems as if “the trend is your friend” mantra has spread from the energy complex to the equity, commodity and forex asset classes. This has caused many investors to forget about an exit strategy. This usually means that at the first sign of a shift in investor sentiment, weak short-sellers will pay anything to take a profit or cover a position that went from making money to losing money in the blink of an eye.
Markets are influenced by three factors: pattern, price and time. Trend trading falls under the category of pattern. Accompanying trend trading is a pattern known as a closing price reversal bottom. Currently, time and price are not that important to crude oil traders.
The only cycle, or time factor that I am watching is the cycle that balances supply and demand, and based on recent data, it doesn’t look like a cyclical bottom in crude oil is due for a long time.
Price isn’t a major factor either with several analysts looking for the market to stop somewhere between $30.00 and $20.00 a barrel. That’s just too big of a window for me.
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Based on the prolonged move down in terms of price and time, traders should be looking for a pattern that will signal that buying is greater than the selling. This pattern is the lower-low, higher-close, or closing price reversal bottom pattern.
Because of the excessive volatility last week and the fact that we are in a news driven market, we aren’t going to spend any time trying to identify a price that will stop the break in crude oil. Additionally, we are not going to try to trade the news either although we feel that a massive of injection of capital into the markets from China will probably be the news that turns crude oil higher.
Markets are influenced by three factors: pattern, price and time
Our primary focus this week will be on trying to find a turn in the crude oil market as soon as possible. This means we will be looking for a closing price reversal bottom chart pattern on the hourly, daily and weekly charts. It’s not our intention to pick the bottom. That is too risky and it usually takes several tries to accomplish, which usually makes undercapitalized traders uncomfortable.
The real reason why we will be focusing on crude oil is because this market is the catalyst controlling the price action in multiple markets. If crude oil can bottom and produce a massive short-covering rally then we believe that this will open up trading opportunities in several markets including the Canadian dollar, Australian dollar and global equity indices. In other words, a bottom in crude oil will encourage short-sellers to begin taking profits in all of the markets that have been driven lower by falling energy prices.
So this week, in addition to trading the trend, all traders should be keeping their eyes out for a closing price reversal bottom in crude oil. Bottoming action in this market will likely lead to bottoming action in the March E-mini S&P 500 Index, or topping action by the USD/CAD Forex pair.
The point of this week’s article is that we as traders wait weeks, sometimes months for correlations in the marketplace to create set-ups that create multiple opportunities that we can take advantage of if we are prepared.
One way to prepare is to identify the markets most correlated with crude oil at this time then prepare to pull the trigger on a trade once we get a bottom in the market. With the fundamentals overwhelmingly bearish and the commodity and hedge funds sizably short, the market is ripe for a reversal bottom and it could begin as early as this week. This should set off a plethora of trading opportunities across multiple asset classes.