It's Time To Trade Natural Gas Again

Over the last five or six months, natural gas has been a dangerous market in which to play, with massive intraday swings being part of sustained long-term moves punctuated by big corrections. Usually, I love to see volatility, because, without it, traders can’t make money, but in this case, it has led me to largely leave natty alone. I am sure all this swinging around made sense to some people, but to me, there seemed to be a randomness to it that put me off, especially as there was good, and to me more predictable, movement in crude over that time that offered plenty of opportunities.

Right now, though, some basic chart reading suggests that we are in a position that sets up a logical trade with a fairly close stop loss and a good risk/reward ratio.

As you can see from the chart above, front end natural gas futures (NG) broke below their 50-day MA (blue line on the chart above) on Wednesday, the first time in four months that that level had even been approached. That leaves us between the 50- and 100-day (yellow line) averages and sets up a possible trade.

This morning, we have recovered a little, taking us back close to the 50-Day MA and shorting NG on the assumption that that level will become a point of resistance would make sense. That is especially true given the strong downward trend with corrections that has been evident all this month. If I take that trade, though, I will want to protect against a break back above the MA. That would involve setting a stop just above the level. The thinking is that if we push and hold above the 50, the original trade thesis no longer applies, and a rethink would be called for.

Often in situations like this, I would set that stop for double the initial position size to reverse the position on a break, but not this time. The kind of volatility we have been seeing recently in NG can lead to some pretty big overruns of technical levels, but they can then reverse quickly. That opens up the potential for losing on both sides of the trade and in volatile markets that is never a good idea.

So, I would keep this one pretty straightforward. A small short position, at say 2.67, with a stop at around 2.72 and an initial target just above yesterday’s low, at around 2.52. If we get there, I would consider taking a profit but would, depending on conditions at that time, also consider just moving to a trailing stop to lock in a profit but also give room to profit should the drop continue and we challenge the 100-Day MA.

Of course, none of this technical analysis means a thing if fundamental conditions switch to a bullish look, but that doesn’t seem too likely at this point. We are approaching the end of November and temperatures around the country are holding up pretty well, indicating that the normal winter surge in demand for nat gas for heating will be delayed a bit. That comes at a time when output levels are recovering a bit after a dramatic drop, so some short-term oversupply is on the cards.

Trading is all about risk, and normally it is something that I embrace. That doesn’t mean, however, that I go out of my way to find it or that I will take it on without the knowledge that I can in some way limit or control it. Natural gas has, over the last few months, presented the wrong kind of risk profile to me, with an unpredictability that kept me away. Now though, with a clearly visible level off which to base a trade, I am prepared to dip my toe back into the water.