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Why Crude Oil Is Poised for a Sharp CorrectionBy
Friday, August 9, 2013
If you hold any bets on crude oil rising, we encourage you to dump them. A correction is headed our way.
A simple boating concept explains why...
Picture a boat... the kind you'd take on the ocean for a fishing trip. Now picture the Dallas Cowboys football team on the boat. If all 53 players are evenly spaced, things are fine. But if all 53 players move to one side of the boat, bad things happen. The boat tips over until lots of Cowboys are shark food.
This situation often happens in the market. When a huge number of market participants take one side of a trade, the market dumps them overboard. That's just how the market works. When everyone gets bullish on something, it's time to get bearish – and vice versa. The market tries to harm as many people as possible as often as possible.
This brings us to the extreme situation in the crude oil market...
We measure the number of people on each side of the oil market with the "Commitment of Traders" report. It's a government report that classifies market participants and tracks their positions. For example, participants in the crude oil market can include oil producers, refiners, and traders who simply bet on price moves.
Many of the oil traders use trend-following computer systems to trade the market. And when those oil traders all move to one side of the trade, they usually get tipped overboard.
Since early June, crude oil has enjoyed a large short-term rally. Prices moved from $94 per barrel to $108 per barrel (a fast, 15% move). This rally has drawn in a massive amount of speculative trading capital. There is now an all-time record of speculative long-side trades in the market. In other words, the speculators have moved to the same side of the boat.
 We believe this massive speculative reading marks the end of the current crude oil rally. The market is ready to punish the speculators. We're not predicting a price collapse to $60, but a decline down to $95 is a chip-shot from here.
Experienced traders can consider shorting a high-cost oil producer, like Canadian oil sands giant Suncor (SU). You can also consider buying an "inverse" fund that rises when oil falls. The largest of these are DNO, an inverse fund, and SCO, a double-inverse fund (which goes up twice as much as oil falls). Keep in mind, these funds don't perfectly track crude oil prices. They end up "bleeding" value.
So the key takeaway for most readers is to make sure you don't hold any short-term trades that need a rising oil price to profit. The boat is badly tipped to one side. The crowd is very bullish. And the market likes to punish the crowd.
Good trading,
Amber Lee Mason and Brian Hunt
Further Reading:
Jeff Clark agrees that oil looks ready to turn lower. "The price of a barrel of West Texas Intermediate crude oil is up almost 20% this year," Jeff writes. But one chart shows "those gains may start slipping away." Get all the details here: How to Profit as Oil Declines.
If you're comfortable taking on a bit of extra risk, short selling the right companies can lead to big profits. But the first step is to know what you're doing. Learn everything you need to know to start profiting on the downside in this interview with Jeff.
Market NotesTHINGS CAN'T BE ALL THAT BAD: A RALLY IN HOME IMPROVEMENT Today, we take a quick look at Lowe's... and note how things can't be all that bad in America.
Over the past three years, we've run dozens of charts that show a simple idea: While things may not be "great" in America, they can't be all that bad. For example, we've noted the super strength in banking stocks, manufacturing stocks, and hotel stocks.
Another demonstration of this idea is the surging share price of Lowe's. Lowe's is America's second-largest home-improvement chain, just behind Home Depot. It's a major destination for people who spend money on bathroom renovations, lawns, new kitchens, and house additions. In other words, Lowe's rises and falls with America's ability to spend money on the American dream.
As you can see from the chart below, the dream is alive. Over the past two years, Lowe's has soared from $19 per share to $45 per share. Just yesterday, the stock reached a new all-time high. We note this strength and state once again: Yes, America has problems… but as long as businesses like Lowe's are doing well, things can't be all that bad.
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