Bottom Fishing In Natural Gas

Over my time writing here I think I have established certain things. One of them is that I don't have a lot of time for those who, from a trading perspective, refer to "bottom fishing" in a derogatory way or constantly point to the dangers of attempting to "catch a falling knife." It seems to me that such people have probably never worked in an actual dealing room, where such things are every day activities. As I have pointed out before, if done in a disciplined manner bottom fishing can be an extremely lucrative pastime.

The discipline, though, is the key. It is important to understand that momentum is powerful, and that stocks and commodities that have been in freefall can continue to decline way past the point where it is logical. It is likely that even though a bottom fishing trade makes perfect sense it could still be wrong. As a result, setting, and more importantly sticking to, tight stop losses is essential. You want to put yourself in a position to make money even if you don't actually get it right until the third try.

With that in mind, I would suggest that it is once again time to look at buying natural gas in some way. The decline in the commodity has been spectacular, falling from a high of around $6.50 in February of 2014 to a 17 year low of $1.61 this morning.

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If that isn't the proverbial falling knife then I don't know what is. The reasons for the drop are well known, fracking has unleashed huge, previously unrecoverable supplies of natural gas in the U.S. and demand for the fuel has also not met expectations. In the short term that is due to an unexpectedly warm winter in most of America and in the longer term the pace of conversion to natural gas has not been what was expected. Hanging over it all has been the lack of the necessary infrastructure to export American gas and access global markets where prices are typically three to four times what they are here.

Exports have recently begun, temperatures have dropped and even tighter regulations on emissions are forcing the pace of conversions, but so far natural gas has shown no signs of arresting its decline, or maybe not until this morning.

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There has been a pretty sharp bounce off of that 17 year low at 1.611. In the grand scheme of things a 4 cent bounce hardly counts as a recovery, but it is enough to encourage somebody like me who is looking for an excuse to buy. The question for traders who want to take this chance is how best to position themselves long natural gas.

The most obvious way is through the futures market, but not everybody is comfortable trading futures. If that is the case then some may want to consider the triple leveraged Natural Gas ETF UGAZ. Instruments such as these are designed for fairly short term use and because of fees and issues with contango don't always give exactly triple leverage to any move, but they are suited to a trade like this.

Buying UGAZ at current levels (around $0.68 at the time of writing) with a stop loss at around $0.62 limits potential losses to less than 10 percent of invested capital, but gives an opportunity for significant profit if this does prove to be even a temporary bottom. The initial target would be a return to around $1, levels that were last seen only a week or so ago, but represent a potential profit of over 40 percent.

It is risk/reward ratios like that that make bottom fishing such an attractive proposition despite what the naysayers would have you believe. At some point logic dictates that natural gas must recover to some degree and betting on that now looks like a reasonable proposition.