One of the most common misconceptions about trading for those new to the game is that the goal is to make every trade a winner. It quickly becomes clear to those newcomers that that isn’t possible. It is important to recognize that reality and be prepared for it by establishing stop-loss levels at the time you initiate a trade, and, more importantly, sticking to them. You should, however, look for trades where the odds are in your favor, and buying natural gas at this time of year would be an example.
As a general rule, seasonal plays in financial markets are risky propositions. The human brain tends to look for order and patterns in things, but just because something moved one way at a certain time of year in the past doesn’t necessarily mean it will in the future. That said, though, as this post at equityclock.com points out, buying natural gas futures in early September and selling in late October has been a profitable strategy in seven out of the last ten years. The chart below, taken from that piece, shows the average seasonal performance on a seasonal basis over the last nineteen years.
A seventy percent strike rate and a total return of over fifty-six percent over a decade certainly makes the trade attractive, but that total return is skewed somewhat by the massive surge we saw last year. That kind of move is rarely repeated, but there is one good reason to believe that we may see another big jump this year. Natural gas futures look to be in the early stages of a massive short squeeze.
Speculative net short positions were at their highest in a decade at the end of August, as the above chart shows. Short sales accelerated towards the end of that time as natural gas futures approached the top of a downward trend channel that started in the spring, but the top of that channel was breached at the start of this month and has powered higher since.
Some of that move up was no doubt the result of some of those shorts being squeezed out, but the massive size of the overall positioning would suggest there is still a lot more of that to come.
There is another, less technical reason to think that this year’s seasonal run up in gas could be one worth playing too…we are now in hurricane season. Predictions for this year are for a “normal” number of storms, but the last few years have seen several devastating weather events affecting the Gulf Coast. You can attribute that to climate change, or just to coincidence if you wish, but it will have a psychological effect on traders.
At some point over the next couple of months, there will probably be a major storm that threatens that area. When that happens, recent experience will be fresh in traders’ minds, and an exaggerated run up in price in anticipation, or even just in fear of, supply constraints as a result could easily result.
The next question is how to position for the move. The obvious way is through futures, but for those who don’t like, or don’t have access to that market, the Velocity Shares 3x Long Natural Gast ETF (UGAZ) will work. Whatever you do, though, trade structure is important. There are good reasons to bet on further gains, but, as I said earlier, you must always prepare to be wrong.
Anything involving leverage will exaggerate the natural volatility of the commodity, but as this is a relatively long-term trade you don’t want to set stops to close to your entry point. That means that positions should be kept small initially so as to keep potential losses manageable. The idea though would be to add to that position if we do see further gains, re-setting the stop upwards as you do.
Buying natural gas at this time of year is a trade with a proven history of success. That doesn’t make it a certainty, but, with suitable trade structure and risk management, it does make it a trade where the odds are in your favor, and that makes it worth a try.