I suppose to most people, the definition of the “perfect trade” is one that makes you a ton of money, but without the benefit of a crystal ball that can identify those, I prefer another definition. To me, the perfect trade is one where fundamental and technical factors combine to suggest a trade with a very good chance of success, but where there exists an opportunity to severely limit, or even better still, eradicate losses should it not work out. Right now, it looks like there is such an opportunity in the volatile world of maritime shipping.
Stocks in that industry have, probably deservedly, been receiving a bad rap lately. The massive swings in Dryships (DRYS) that followed a devastating series of reverse splits, for example, left many with the distinct impression that that stock was being manipulated. The swings were less drastic at Navios Maritime (NM), but there too, reverse split followed reverse split as the stock collapsed last year.
In fact, pick almost any maritime shipping stock and glance at the chart, and it is quickly clear that there are desperate problems in the industry. Nor are these just recent problems, as this chart ably demonstrates…
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The long-term problems relate to over-commissioning and the resulting over-indebtedness in the industry in the run up to the last recession, while the more recent issues have come as global growth concerns have prompted a collapse in freight rates, as shown by the one-year chart for the Baltic Dry Index (BDI) below.
(Click to enlarge)
What the chart also shows, though, is that the BDI has been gradually edging up after hitting a bottom just below 600 in early February. There is of course no guarantee that it won’t go lower, but that level has only been breached on two other occasions in the last five years, and each time has been followed by a rapid bounce back.
And there is another fundamental factor that may give shipping stocks a short-term boost. Upcoming changes in the regulatory requirements for the fuel that ocean-going ships use is distorting that market. Even though it has led to a drop in inventories in expectation of reduced demand as the shift occurs, futures for the fuel are in backwardation, a situation that predicts falling prices. That is in anticipation of a shift to the new, lower Sulphur fuel but, for a while, it will just reduce costs for shippers.
So, we have the prospect of higher rates and lower costs, even if it is just for a few months. The question is, how best to -play it.
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Because of the look of the chart (above), my choice would be Scorpio Tankers (STNG). In some ways it is not a perfect fit as they are, as the name suggests, a tanker company rather than dry shipping, but if overall rates climb and fuel prices fall, they can still benefit, and the setup just looks too good to miss.
As you can see, STNG has been a bit of a trader’s dream since the beginning of October, bouncing around within a range roughly defined by $15-22, which gives ample room for profit in both directions. We are now close to the top of that range but if, as the fundamental picture suggests, there is a chance of a near-term rally for shipping stocks, a breakout could come soon. If it does, the previous reliability of the range will help as there will be plenty of shorts near the top of the range to be squeezed.
What makes this so appealing to me though, is what happens if we do start to drop back into the range. In that case, a drop close to the low looks most likely, so the preferred trade structure would be to buy here, just below $20, with a stop loss order for twice the amount at just below $18. That way, if STNG heads lower, you would be short, and if it reached $16, you could be out just about flat. When shorting, there is always a potential issue with availability of the stock and there are additional costs to consider, but STNG is fairly liquid, so it shouldn’t be too much of an issue.
Obviously, something like this would be a trade, not an investment. As such it involves significant risk and demands your attention, so if you aren’t comfortable with both of those things, it’s not for you. Still, it is an illustration of the kind of thing that if you are, you should be looking for: a trade with a fundamental basis and a technical setup that increases the chances of a rapid move yet allows for the possibility of you being wrong.