Don’t Let Oil Markets Scare You, There Is Still Money To Make

The last year or so have been, to say the least, painful for long term oil investors but, as I have said before, for traders it has been an almost perfect market. The sustained downwards trend with consolidation and small rallies at or just below logical support levels has presented multiple opportunities for two way trading. We saw the pattern repeat again this week as WTI pushed lower, breaking through $35 and then bouncing off of the 2008 lows at around $32. That bounce has been sustained in early trading today (Friday), and that sets up the chance for another chance at a trade that has been profitable around other support levels recently.

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The basic idea is to short oil in the $33s with a view to reversing that position and going long just below $30. This concept of selling something that you ultimately want to buy often seems strange to those without a trading background, but it is a common tactic in dealing rooms around the world.

The bounce off of the support was a kind of kneejerk reaction, but the fundamental factors that have pushed oil even lower haven't changed. The Saudis are still using the price of oil as a weapon against their enemies in the region, ISIS and Iran. Production levels in the U.S. are still elevated. There are still concerns about global growth, particularly in China. All of this is true and in the current climate of fear bordering on panic in the oil market that means that any rally will be short lived. If selling re-emerges and we push down towards $30 then breaking that level look almost inevitable.

At some point, though, the selling will start to look overdone. The Saudis cannot go down this path forever for two reasons. Firstly, as their proxy war with Iran in Syria and Yemen threatens to turn into direct conflict, hurting their enemies by lower oil prices will take a back seat to financing their own military needs. Secondly, before too long forcing prices even lower will put the very structure of OPEC, which has served the Saudis so well for so long, at risk. In addition the slowing in China is being offset by a somewhat resurgent Europe and strength in the U.S. economy, and is also, while slower than most would like, still growth.

In the short term, then, WTI looks set to break below $30 but a bounce from there would fit the pattern of what has happened at support levels for the last year and a half. We break through them, then bounce, and then sink even lower. That has just happened at the historical lows and there is no reason to think it will not again at the psychologically significant $30 level.

The idea would be to sell WTI at around $33 with a stop loss at around $34 and an initial target of say $29.75. If that level is reached then you would reverse the position, leaving you long at an effective level of around $26.50. A stop loss then at $29 would guarantee a profit and leave a lot of room for appreciation on the bounce back. Those that trade futures could do this through that market, but if you don't you can still replicate the trade using leveraged ETFs, such as DWTI for the initial short, switching to UWTI for the long portion of the trade.

Whether you take this trade or not, however, and how you do it if you do, there is one thing that should be stressed. The longer the selling goes on the closer we get to a rapid bounce back, so ultimately you should be looking to position yourself for that when it comes. Sometimes, though, the best way to do that is to sell in the short term to give yourself room to run in the long term; just be careful to protect yourself with an appropriate stop loss if you do.