What Caused the Drop? (and how to play the bounce)

Big Opportunities in Energy This Week!

It’s been quite a start to the year in energy!

Oil futures collapsed nearly twenty-five percent from their early January highs before bouncing a bit from a low just below $50. That level has held for a week, but there is still no sign yet of a strong upward move. That sure sounds like bad news for energy traders and investors, but is it?

Not necessarily. Any big move is an opportunity for those who know how to profit from it, and that’s where Deep Earth Publishing comes in.

My job here is to track the moves, analyze the causes and turn any move, up or down, into a money-making opportunity. The bigger the move, the bigger the opportunity.

What Caused the Drop?

At the start of this year, when the hews came that a missile attack by the U.S. had killed the Iranian General, Qasem Soleimani, oil jumped. There is an ever-present threat of violence in the Middle East that will impact oil supplies, and this looked like a possible trigger for all-out war.

However, when it was clear that the immediate Iranian response was measured and designed to avoid just that, oil quickly lost all the ground it had made. That sudden reversal started to flush out a lot of long positions and the downward move gained momentum.

The focus shifted back to where it was earlier in 2019: slowing global demand and increasing U.S. supply. In that environment, not even positive news on trade and the signing of a phase one deal between the U.S. and China could cause more than a brief halt to the decline.

The fact is though, those things happened and will have a long-term impact.

Why Was it So Big?

After the first week of the year, a correction of some kind in crude looked inevitable. In the last quarter of 2019, CL, the main futures contract for WTI, had moved up from around $51 to over $65. That had two notable effects.

First it meant that by the time we hit $65, every conceivable positive influence on the price was priced in. That made further gains unlikely.

Second, it meant that market positioning had shifted to where most traders and funds were long. That meant that momentum could build quickly on any correction.

Once crude turned and that momentum was established, another factor added to it.

The coronavirus.

The spread of the virus out of China raised fears that it would negatively impact global trade and commerce and that pushed oil lower still. Those are legitimate fears, but they were just as legitimate about SARS, MERS and Ebola, and we moved on from all of those without reaching Armageddon. At this point, good news about the containment of the virus is far more likely than anything that worsens the outlook.

Now, we seem to be at the opposite point to where we were in early January. All the potential bad news is priced in at these levels, as evidenced by the fact that when OPEC cut their demand outlook on Wednesday, oil barely moved.

Then there is the OPEC+ group. They have talked about extending the output cuts to offset the coronavirus effect and while it might not come to that, more talk can be expected and that too will lend support.

What Next?

Apart from the logical and fundamental reasons, there are good technical reasons to believe that there will be a retracement of the move down, if not a full reversal, and that that is about to happen.

If you look again at the chart above, you will see that every major reversal of a move over the last twelve months has been preceded by a “final gasp” big move in the direction of the momentum.

That is no coincidence.

I have made a living from markets for nearly forty years, and that pattern is common to all markets. It is caused deliberately by traders. They know that it is possible to squeeze out positions and exaggerate a move and will use any excuse to do that. Then they reverse positions and leave the market caught the other way.

This looks like just such a squeeze. The long positions have now become short positions, leaving room for a significant move back up.

Look again at the chart and you will see that the latest move down followed a classic “Elliott Wave” pattern, with the five waves marked by the blue lines. Once the fifth wave of such a move is complete, as it is now, we reset, and the next move could be in either direction.

Given that the new low just above $49 has now been tested again and held, the most likely next move is upwards.

How to Play It:

The obvious move to profit from the bounce would be to buy WTI futures, but in this case, that may not be the best play.

I would want to set up this trade to allow for partial profit taking at the initial target, and if you bought multiple contracts of CL in order to give that flexibility, it could get very expensive very quickly if things don’t go your way. There is a chance that there will be one more push down, so you need to allow for that possibility when setting a stop loss order. That would mean setting a stop loss order over $2 lower than crude’s current price.

For that reason, the best play here is the 3x leveraged bullish oil ETF, UWT.

The previous low of UWT of 8.56 on October 3rd came when WTI hit a low of $50.99. The nature of the ETF means that there is no exact comparison with previous lows, so this time UWT went well below that, hitting $7.32 on a low of $49.31 in crude.

This is a short-term trade with potential for longer-term gains, so the parameters need to be set to allow for both eventualities. If there is a clean, sustained break below $49, the support has failed to hold, and you would want out. For that I would set a stop-loss order for UWT at around $7.20.

The initial target would be a thirty-eight percent retracement of the move down, a level indicated by Fibonacci retracement analysis, that would equate to just above $10.60.

At the time of writing, UWT is trading at around $8.15, so your potential loss on the trade would be just under 12%, with a potential profit at the $10.60 target of around 30%.

That is a risk/reward ratio that works in your favor, but there may be even more upside. This looks like a double squeeze, and if that is the case, the gains could be significantly more. That level would not necessarily be a place to sell everything, but it would be a good place to take some profit initiate a trailing stop on the balance to maximize potential profit.



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