Since the oil crash first began last summer, I have constantly been asked how low I think Crude Oil prices could go, and especially so the past few months. My answer has been pretty consistent, “I have no idea”. To me there have been so many easier trades to be in out there that messing around with this disaster hasn’t been worth the aggravation. As a market participant that has to allocate assets and manage risk responsibly, fooling around with crude oil has not fit our risk profile with respect to any potential upside. It just hasn’t been there.
As you guys know, we sell the research that we do, which is essentially the homework done for our hedge fund. Members of our Commodities & Currencies reports received a potential road map of what we wanted to see in Crude Oil before getting involved. One of the things that we wanted to see a few months ago was a rollover to new lows while momentum simultaneously diverged positively. Until then, this wasn’t something we wanted to bother with.
Well I actually think we might be getting that. Over the past couple of weeks Crude Oil prices have rolled over and are hitting levels not seen since early 2009, right around the time that the epic 200% rally first got going. I use a 14-day RSI as my momentum indicator and on these new lows in price, RSI is putting in a higher low. Here’s what it looks like:
From a risk management perspective, there is zero reason to own Crude Oil if prices are below the January lows. So at the very least, we have a clean level to watch. It is marked by the gray shaded area. Above the January lows, and I believe that a mean reversion could really get going. Look how extended the price is from the mean (defined by a 200 day simple moving average).
So here’s how I see it. We know that sentiment right now is near historic bearish extremes rarely seen in the past. So that’s one for the bulls. Second, it looks to me like the US Dollar has put in at least a temporary top (see here and here). If that is indeed the case, that’s gotta help Oil get a little boost. Seasonally, this is the most bullish time of the year for Crude Oil prices as we exit the worst period. And finally, most importantly, this new low the past 2 weeks could be a whipsaw. If we break back above the January lows, this confirms a bear trap leaving all the new shorts caught under support and all the longs that were stopped out of the trade now have to buy it back. This creates momentum as all of the wrong shorts get squeezed and have to cover while all of the longs stopped out have to re-buy. When momentum guys like myself catch this, more buying comes in, not to mention the natural buying already taking place anyway. This then leads to more short covering and more longs “not in the trade” re-buying.
Granted, this is all the best possible scenario here that could create an epic short-squeeze to take crude oil north of $70. From a risk/reward standpoint, there a very few setups that are skewed this much in one’s favor. If we never break out, then who cares. We’ve remained patient this whole time, what’s another few weeks/months? And if we buy the breakout and we rollover again and get stopped out? Oh well. I’d take that risk/reward 100 times out of 100, which is the only thing that really matters to me.
Gun to my head? I think we break out and I’m an aggressive buyer of that breakout.
Tags: $USO $CL_F $DX_F $UUP