To riff on an old joke about comedy, the secret to success in trading is ………….. timing. It is sometimes hard for people to grasp, but what you buy or sell is in many ways less important than when you buy or sell it. Being right in the long term does you no good if you are forced out of the position because you are very wrong in the short term.
That is worth remembering when it comes to crude oil right now.
To anyone like me with a penchant for the contrarian like me, this chart is catnip.
I mean, look at that big collapse…the bounce from that is going to be spectacular!
That view is not just based on contrarianism, however. It is also based on history. Look at the 1-Year chart above for the main WTI futures contract, CL. Over that time, we have seen two similarly sharp drops in crude, in May and September.
Both, like this one, were immediately preceded by a big up day, and both were followed by big retracements. As if that doesn't make buying into this drop tempting enough, they are four months apart, and this collapse has come four months after the last one. That doesn't mean anything at all, of course, but the human brain seeks order, so the rhythm to the spikes and collapses will give the trade subconscious appeal.
The problem is that buying here would be a perfect example of attempting to catch a falling knife, something that traders frequently tell each other is dangerous. Contrarian trading…
To riff on an old joke about comedy, the secret to success in trading is ………….. timing. It is sometimes hard for people to grasp, but what you buy or sell is in many ways less important than when you buy or sell it. Being right in the long term does you no good if you are forced out of the position because you are very wrong in the short term.
That is worth remembering when it comes to crude oil right now.
To anyone like me with a penchant for the contrarian like me, this chart is catnip.
I mean, look at that big collapse…the bounce from that is going to be spectacular!
That view is not just based on contrarianism, however. It is also based on history. Look at the 1-Year chart above for the main WTI futures contract, CL. Over that time, we have seen two similarly sharp drops in crude, in May and September.
Both, like this one, were immediately preceded by a big up day, and both were followed by big retracements. As if that doesn't make buying into this drop tempting enough, they are four months apart, and this collapse has come four months after the last one. That doesn't mean anything at all, of course, but the human brain seeks order, so the rhythm to the spikes and collapses will give the trade subconscious appeal.
The problem is that buying here would be a perfect example of attempting to catch a falling knife, something that traders frequently tell each other is dangerous. Contrarian trading is, by definition, about going against the flow but that doesn't mean that you should try to swim upstream in a river in full flood.
You have to wait for a logical entry point. It's that timing thing again.
That logical entry point could be lower. following further declines, or it could be higher, following evidence of a bottom forming. Whichever of those turns out to be true though, it is not here, and it is not now.
On the downside, the logical entry point for a long trade would be somewhere close to the 52-week low of just below $51. That level has proven to be significant on multiple occasions so it is likely that there will be at least a pause in the trop should we get there. It also serves as a good basis for a stop-loss order if you buy just in front of it.
Contrarian plays rarely work the first time, no matter how logical your entry point. Big drops such as we are seeing now in crude have their own life. Once well underway, they are fed by fear, and logic and fear rarely live together. In a full-fledged collapse, even the strongest support point becomes vulnerable, so while using one as a trigger for a trade makes sense you have to stay fully aware that it may not work out.
That means placing and sticking to a fairly tight stop.
In this case, I would look for an entry point at around $52, with a stop set just below $50. That would limit losses to around a 4% move.
There is, however, a chance that a bounce will begin soon. At the time of writing, CL is trading at around $54.40 and there is a potential support level at $54.11. That represents a 78.6% retracement of the move up, a significant level in Fibonacci terms.
That could be enough to prompt a bounce, but we would need to break above the 61.8% retracement level at $56.55 for it to really mean anything. If we were to get there, that would make CL a buy, again with a stop loss just below the support. In this case that would mean a stop just below $54, again limiting potential losses to a move of around 4%.
Contrarian trading is appealing on two levels. It appeals to the ego, because there is nothing better than the feeling that you are so much smarter than the market. You got it right when everybody else was wrong! Take that, high school bully, or ex-wife, or whoever!
But it is also appealing from a more practical perspective…when done right, the risk/reward ratio works massively in your favor. In both cases above, stop-losses would be set based on a 4% drop, but a 78.6% retracement of the move down would mean a 21% gain from a $52 entry point and even the higher entry would give three times as much potential profit as the potential loss. Those are numbers any trader can live with.
At some point, a bounce will come, and buying crude will be the right thing to do. That doesn't mean, however that it is the right thing to do now.