Sometimes markets are driven by trend-traders following hard supply and demand facts, sometimes they are driven by speculative buying in anticipation of a change in the fundamentals. The three major energy markets – crude oil, gasoline and natural gas – have demonstrated both sides of the equation this summer.
Currently the energy markets are being driven by stories of what could happen rather than what is happening. Every week, it seems we are told about excessive supply, excessive production and low demand, yet the three main markets remain firm.
Every week, we are reminded that there is a supply glut in crude oil and that the U.S. rig count is rising. We are told that gasoline inventories are relatively high and that automobile owners are driving less. We are also reminded of the near storage capacity of natural gas supply and the relentless production.
But that’s the way summer markets tend to trade. Vacations and other activities tend to lead to lower than average volume. Money managers following the main trend seem to be on autopilot, working the trade when it’s going in the direction of the main supply/demand fundamentals then taking profits or squaring positions when conditions change due to rumor and innuendo.
For example, when crude oil started to trend lower on bearish fundamentals, the hedge funds and money managers heavily shorted the market, creating a record short-position. They were simply following the bearish fundamentals. When the rumors hit that there might be a production freeze, they aggressively covered their positions while booking profits.
Natural gas prices have been supported all summer by lingering heat domes and recently by concerns about a tropical depression, thousands of miles away, moving into the Gulf of Mexico and putting natural gas rigs at risk. However, the strict fundamentals indicate we may hit full capacity before the winter heating season.
The point I am trying to get across is that as a trader you have to be flexible. At times traders are going to be locked into the current fundamentals and others times on what could happen in the future. It all comes down to reading the order flow and studying unconventional indicators like the Commodity Futures Trading Commission’s Commitment of Traders report.
I find that most traders are tuned into prices or fundamentals, but it is knowing what side of the market the big money is tracking that makes the difference. So it is suggested that you add to your toolbox of trading weapons a few tools to monitor the major players along with a smattering of reliable news services to track the speculators.
The bigger traders tend to follow the fundamentals while the small speculators tend to follow the news. If you watch the weekly Commitment of Traders reports and the daily order flow and open interest in conjunction with the charts, you should be able to over time, determine who is running the show and whether the moves will be long-term or short-term.
(Click to enlarge)
We’re going to take a look at the swing chart and retracement zones this week.
The main trend is up according to the weekly swing chart. Despite the June to August sell-off, the main trend never turned down because no main bottoms were violated. Momentum may have been to the downside, but the bullish chart pattern remained intact.
The current weekly chart pattern tells us that the uptrend will be reaffirmed on a trade through $53.62 and it will turn down on a trade through $41.58. That’s a pretty wide range which makes the retracement zones even more important because they chop these range into 50% and 61.8% slices.
The main range is $34.06 to $53.62. Its retracement zone is $43.84 to $41.53. The recent bottom at $41.58 the week-ending August 5 occurred into side this zone. The turn at that price was quick and decisive because short-sellers tend to use the zones a profit-areas and speculative traders tend to use them as entry-areas.
The intermediate range is $53.62 to $41.58. Its retracement zone at $47.60 to $49.02 is currently being tested. After taking out this zone the week-ending August 19 and rallying to $50.59, the market corrected back into the intermediate retracement zone after the buying and short-covering stopped.
The $47.60 to $49.02 zone is very critical to the short-term direction of the market. This is because at this zone, buyers will have the choice to drive the market higher and into the main top at $53.62. Sellers have the opportunity to stop any rally and form a potentially bearish secondary lower top. If this occurs then it will send out a signal that the short-sellers are in charge and that crude prices are headed lower.
So essentially, during the week-ending September 2, the direction of the market will be determined by trader reaction to the Fibonacci level at $49.02 and the 50% level at $47.60.
Look for the bullish tone to continue on a sustained move over $49.02 with $53.62 the next likely target. Watch for a downside bias to develop on a sustained move under $47.60 with the first target zone $46.09 to $45.02.
While watching the price action at these levels, keep an eye on the order flow and pay close attention to the Commitment of Traders report to determine whether the funds are shifting money to the long side or trying to rebuild their short-position.