One of the things that it is important for traders to understand is that markets have a natural tendency to overshoot. The classic zigzag pattern either heading up or down that most people think of when they think of a stock chart is the direct result of that. When a move starts, momentum builds to the point where an overshoot from the logical endpoint of that move is inevitable, and when that point is reached a correction ensues. That too will overshoot and the move resumes in the original direction, momentum builds to push it just a little too far again, and another correction follows…etc, etc.
Nothing has been a better example of that recently than natural gas futures. First, the climb up from around 2.50 to around 3.35 that started in the middle of August had the classic Elliott Wave look that comes from this tendency, with three up waves and two correcting down waves. Once that pattern finished at the high of 3.366 we started on an extreme example of it again as NG, the natural gas futures contract, collapsed around twenty percent in under two weeks then jumped twenty percent from that mark in just a couple of days.
(Click to enlarge)
That push back up above $3 proved to be very short lived though, and this week we have dropped back into the 2.70s. It would be logical, therefore, to assume that we are going even lower from here, but action over the last two days suggests that that is not the case, and that view is supported by fundamental…
One of the things that it is important for traders to understand is that markets have a natural tendency to overshoot. The classic zigzag pattern either heading up or down that most people think of when they think of a stock chart is the direct result of that. When a move starts, momentum builds to the point where an overshoot from the logical endpoint of that move is inevitable, and when that point is reached a correction ensues. That too will overshoot and the move resumes in the original direction, momentum builds to push it just a little too far again, and another correction follows…etc, etc.
Nothing has been a better example of that recently than natural gas futures. First, the climb up from around 2.50 to around 3.35 that started in the middle of August had the classic Elliott Wave look that comes from this tendency, with three up waves and two correcting down waves. Once that pattern finished at the high of 3.366 we started on an extreme example of it again as NG, the natural gas futures contract, collapsed around twenty percent in under two weeks then jumped twenty percent from that mark in just a couple of days.
(Click to enlarge)
That push back up above $3 proved to be very short lived though, and this week we have dropped back into the 2.70s. It would be logical, therefore, to assume that we are going even lower from here, but action over the last two days suggests that that is not the case, and that view is supported by fundamental factors.
What the above chart says to me now is that we are forming a bottom around the same levels as those that marked the end of the down wave in September, and if so the real overshoot here is in this recent correction. If that in turn is true then we will be heading higher again soon. It isn't just the chart that suggests that either. What caused that huge gap upwards last week was a lower than expected build in inventories. This week's number met expectations, which suggests that last week was not a fluke and that maybe demand really is catching up with what has been an oversupply for a long time.
The price of WTI, as a benchmark for U.S. energy prices generally, also has an effect on natural gas, and further support could come from that direction. Oil has dropped a long way in a fairly short time recently and, with the dollar looking to have turned lower and the OPEC meeting approaching, an upside correction looks to be on the cards as that market approaches an important support level at around 43.20.
(Click to enlarge)
All in all then this looks like a case where the market has found a bottom at the end of a correction, and that could well be the case. Given the aforementioned tendency of markets to overshoot, however, that doesn't mean that buying right now is the best strategy. Even in a situation like this, where all factors point to a rebound, it makes far more sense to wait for the confirmation of a bottom than to attempt to catch the proverbial falling knife. If we begin to turn back upwards in the next couple of days, or even stabilize at these levels, then it will set up a trade with a stop loss just below yesterday's low of 2.725. That would be an ideal situation, but for now it will pay to hold off until a real reversal is clearly taking place.
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