More Volatility To Come For Oil In October

If you are someone who has been reading my articles for a while, you will be aware that I try to be accountable if nothing else. I make mistakes and miscalls, like everyone does, but I learned a long time ago that one of the biggest factors impacting success or failure in trading is being able to understand and freely admit that. Doing that as a writer, however, makes no sense. Readers tend to judge financial writers on their immediate impression of each article they write, and, like bad traders, they remember the good trades and forget the bad. So, why damage my brand by pointing out a time when I got something as wrong as can be? I can't say why because it makes no logical sense, but doing so is so ingrained in me at this point that I just can't help myself, and it does sometimes have advantages.

This week, for example, I am writing a mea culpa regarding one of the worst calls I have made for a while. Right at the start of this month, I said that I would be trading WTI futures with a short bias for a few weeks. Here is the chart since then…

As you might imagine, favoring short positions during a time that looks like that on the chart hasn't been particularly profitable. It hasn't been a complete disaster because, as I pointed out in that piece, for me, "short bias" doesn't mean going short and watching and waiting, nor does it mean taking only short positions intraday, but September hasn't been a great month all the same. Still, admitting when you are wrong does have advantages other than limiting losses. It enables you to look at where and why you were wrong and to reassess the situation.

Doing that this time around, it was clear that my mistake was to overemphasize the demand side of the pricing equation for oil at the expense of the supply constraints that have pushed crude higher since this rally began in June. I still believe that monetary and fiscal policy here in the US and elsewhere in the developed world are going to cause a significant slowdown in growth, and maybe even a full-blown recession, which will cause a big drop in oil demand at some point. However, that hasn't happened yet, and with both OPEC+ and market driven producers adjusting for the expectation of lower demand that hasn't yet materialized, the market is even tighter now than it was a month ago.

The obvious question, then, as I do my usual end of month review of the fundamentals that drive oil is, what next? Well, as I said, I still believe that higher interest rates globally, particularly after starting at such a low level where money was essentially free, have to cause a significant slowdown in economic activity. And I am also certain that most traders and investors, or at least those whose careers started before interest rates went to zero, believe it too. What they are betting on right now, though, is that the extraordinary slack in the US and global economies that was initially the result of a decade of ultra-loose monetary policy, and that was then was exacerbated by the pandemic, will continue to allow economies to absorb higher rates and will therefore delay that impact.

So, with that in mind, reaching the psychologically significant $100 level for WTI looks to be on the cards and, given the tendency of traders to push harder when the market gets close to those big round number levels, may well come quite quickly. That leaves me in an unusual situation. I am bearish overall but believe that the short-term outlook is quite bullish. That is a conundrum, but it is one I have faced many times before, and there are ways to trade it.

The key is to separate short and long term positions. I can take an underlying position that fits with my long-term bearish view, such as beginning to average into something like SCO, the 3x leveraged inverse crude ETF, but trade in the short term with a long bias, looking for that move to just above $100. That is not as silly as it may seem at first glance. The point is that I believe that oil will be lower at some point before too long, but what I don't know is when that downward move will start. By taking two seemingly contrary positions, going short oil via something that I will hold for days or weeks with wide parameters, while trading futures with a long bias and tight parameters in time periods measured in minutes or maybe hours, I can position myself for a drop, but still make enough money to more than cover that should crude remain strong for a while.

That is what I intend to do during October. It may or may not work out, but you can be sure of one thing. If it doesn't you won't find me hiding from my misjudgment or pretending that I never said what I did. I will admit it, reassess, and move on. Doing that has served me well over forty years in financial markets, and I see no reason to stop now.