Simple Risk/Reward Makes Natural Gas A Logical Buy
By Martin Tillier - May 21, 2016, 7:00 AM CDT
There really is no better thing for a trader than when something, a stock, commodity or whatever, gets stuck in a range. It gives the opportunity to buy and sell at obvious levels with the added bonus that you can even make money when you get it wrong and the breakout comes. Over the last month or so natural gas futures have fitted that bill.
(Click to enlarge)
Chronic oversupply in the U.S. market has put a top on gas at around $2.20 since February, but each time prices sink below, or close to, $2 the reality kicks in that it can only really go so low. At some point this sustained run of depressed prices will cause production cuts in some way shape or form, so buyers will always surface at those levels.
For over a month now going short at just below 2.20 and long just above $2 with stops at $2.10 and $1.90 respectively has been a fantastic trade, and there is no reason to not try it again here, but it is beginning to look like the end is in sight. There is already evidence that the E&P and capex cuts that U.S. firms made at the end of last year are beginning to affect oil production, a fact that has been at least partly responsible for oil’s strong rally since the end of February.
(Click to enlarge)
Natural gas, on the other hand, has failed to respond to the prospect of reduced supply, and for two main reasons. The first is that the U.S. market was so massively oversupplied last year that even the kind of reductions we…
There really is no better thing for a trader than when something, a stock, commodity or whatever, gets stuck in a range. It gives the opportunity to buy and sell at obvious levels with the added bonus that you can even make money when you get it wrong and the breakout comes. Over the last month or so natural gas futures have fitted that bill.
(Click to enlarge)
Chronic oversupply in the U.S. market has put a top on gas at around $2.20 since February, but each time prices sink below, or close to, $2 the reality kicks in that it can only really go so low. At some point this sustained run of depressed prices will cause production cuts in some way shape or form, so buyers will always surface at those levels.
For over a month now going short at just below 2.20 and long just above $2 with stops at $2.10 and $1.90 respectively has been a fantastic trade, and there is no reason to not try it again here, but it is beginning to look like the end is in sight. There is already evidence that the E&P and capex cuts that U.S. firms made at the end of last year are beginning to affect oil production, a fact that has been at least partly responsible for oil’s strong rally since the end of February.
(Click to enlarge)
Natural gas, on the other hand, has failed to respond to the prospect of reduced supply, and for two main reasons. The first is that the U.S. market was so massively oversupplied last year that even the kind of reductions we are seeing leave a glut, and unseasonably mild weather has perpetuated questions about the level of demand. There is also the fact that in the U.S. natural gas is essentially a closed market…there have, until very recently been no exports.
That situation, though, is beginning to change and that is coming just as supply is starting to show signs of turning downwards and as the prospect of a long, hot summer in the U.S., and therefore energy demand for cooling, is being considered. Given those conditions, this could well be the time when gas breaks out of the 2.20 resistance. If that were to happen, then, from a chart perspective, the way would be clear for a rapid jump to around $2.50, nearly 25 percent above where we are now.
The point about buying here now, though, is that it represents a great risk/reward profile. A stop loss order at around $1.90 limits potential losses to less than 10 percent and even that could probably be lessened by using that level as a reverse point rather than just a cut. If we get there the range is broken and switching from long to short at 1.90 would give a good chance of recovering that small loss on the basis that if we get there a run towards the low around 1.60 would look to be on the cards.
Far more likely though, given the fundamental situation, is that gas runs back up to the 20 level, pauses for a while, and then breaks out to the upside. That is why, while playing the range again in terms of buying at around $2 I will be holding on if we hit $2.20 this time, looking for a much bigger profit. In fact, if that happens I will probably not even cut at $2.50, but will instead just move to a trailing stop and let it run.
There is an old adage in trading and investing that, eventually, everything returns to the mean. There are perfectly sound reasons why natural gas has stayed this low for this long but at some point it will recover some of the lost ground. With the proximity of a cheap stop and reverse level, now is as good a time to bet on that as any.
