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The Reaction To The OPEC Deal Extension Is Logical, But Flawed

Those new to financial markets, and energy trading in particular, were probably somewhat puzzled by the price action in oil futures this week following the announcement by OPEC and some influential non-OPEC nations that they are extending the production cuts agreed last year for another nine months, until the end of Q1 2018. The logical reaction to that news would have been a spike in oil, but instead we saw a dramatic decline of around five percent once the announcement was made. That is easily explained in terms of trading dynamics, but one question remains. Is it a sign that we are heading lower or does it represent a good short-term buying opportunity?

(Click to enlarge)

“But the rumor, sell the fact” patterns like this are extremely common, and are the logical result of declaring the intent to enact a policy before actually doing so. Various OPEC members have made it clear over the last couple of weeks that an agreement was coming, so traders inevitably positioned themselves for that in advance of any actual announcement. Those statements, however, also set the rumor mill grinding and the whispers began to assume that more was coming. The market began to price in deeper cuts, which were never indicated, and when they did not come the extension became a negative for oil. All those traders that had taken long positions rushed to get out, and the ensuing results can be seen on the chart. That proves a point that I have often made here,…

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