SCSO="Second Chance Shorting Opportunity".
Lets take a look at USO, the VERY likely head fake move and how you can enter the trade at lower risk and higher probabilities.
USO was added to the equities model portfolio as a core short position at the price of $35.16 at a current loss of -0.64% on the position and approximately less than 1/10th of 1% portfolio risk, even though I almost never have time to figure out risk management in these positions, I do have several rules and have a rough idea from years of trading, approximately what position size is appropriate for risk management purposes which I try to stick to as a matter of habit.
So where was the trade in USO, where is the trade and what is the situation for USO.
First of all, most traders go about picking a trade in the absolute wrong order and look at the wrong things when picking a trade. I should not have entered a position in USO from a portfolio management perspective, but I'm not using the model portfolio to do anything but track trades and provide examples. The reason why USO was not a good trade from a risk perspective is because I already have 2 Energy related trades in XOM short and IOC, while USO is a bit different, it's still in the same Industry group and 3 full size positions is too much correlation.
Now, what I like about USO:
Oil is usually very correlated to currencies, specifically the $USD which oil trades in $US dollar denomination the world over. Because the relationship tot he dollar is an inverse relationship, unless you are very good seeing divergences even in reverse, using the $USD is difficult for most people to spot correlation or FX legacy arbitrage correlations. Since the Euro (EUR/USD) by far has the most weight in the Dollar Index (50%), the Euro makes for an excellent $USD proxy that trades with oil so divergences are easier to see.
Example...
USO is green, the Euro (FXE) is red, note the negative divergences between the two that have led to a downside correction until the two reach "reversion to the mean". The Euro is weaker than it should be considering the USO trend up since the June lows, meaning the $US Dollar is stronger than the price of USO reflects. When the dollar gains in value crude loses value due to the higher value of the dollar, when the dollar falls, the price of crude must rise to compensate for the reduced buying power of the dollar. We have a clear divergence.
As shown earlier in the currencies post Euro weakness/$USD strength should continue making the value of USO rich compared to the FX (currency) legacy arbitrage correlation.
Furthermore the weakness in China is evident and has been for some time, this means demand for crude directly from China should be soft and that flows down the line.
A 2-day chart of the SPX (green) vs the Dow Jones/UBS Commodity Index, changes were visible in 2011, I mentioned the weakness in commodities generally and how I thought it reflected weakness in China, within two weeks of that post we had evidence of a softening Chinese manufacturing sector via PMI, both manufacturing and services. It only makes sense as the EU is China's #1 trade partner and the EU has financial problems. Further evidence can be found in the
Baltic Dry Index-even though this is the price of dry shipping, it is evidence of the economies world wide.
Over the last 3 years the BDI has seen a decline of 80%, while the BDI is notoriously volatile, the trend and the 80% decline in 3 years is a clear sign of economic activity.
Further confirmation can be found in simple Dow Theory, Industrials vs. Transports;
this is not only a sign of economic activity falling off which is not good for oil prices, but this also is confirmation of our bearish view of the market as this measure of Industrial (actually the Dow-30 is much broader than just Industrials now, but the same effect is still relevant).
The Dow 30 is in green while Transports (IYT) are in red. Clearly from the August 2011 low through the February 2012 area, there was good confirmation between the two, that fell off in March- May of 2012 where we were busy shorting the market and it has once again fallen off badly since the June 4th market bottom.
If you also pay attention to the weekly EIA petroleum report, than you'll know even though we've had a recent string of draws from reserves, the level of reserves are near the historic highs, which does not bode well for additional near term demand. In truth it has been fundamental surprise risk associated with Iran and Syria that has kept oil at a premium, however as we near elections, it is doubtful that starting any kind of military intervention with so many countries now involved and elections just around the corner, the chances of intervention have diminished as starting a war is not likely to benefit Obama at the polls.
Technical Indications...
The daily chart of USO looks a lot like a primary downtrend with a recent counter trend rally, I know BIDU has been a frequent example, but it is a similar trend situation. Volume dies off in to the counter trend move as well. The yellow vertical arrow appears to be the head fake high.
The retracement of the downtrend is almost exactly 50%
On the retracement there was a gap resistance area filled, from there we had a higher volume reversal candle that was already part of a bearish Engulfing reversal candle above the head fake level.
If you like MACD Histograms, you can see both the positive divergence at the bottom and negative divergence at the top.
On the 4 hour 3C chart the original top is called out as is the positive divergence at the bottom and the distribution at the head fake area, this is a VERY long timeframe and an important signal, there's little detail and mostly trend at the important areas.
Even a daily MoneyStream chart calls out the first top (see relative price/MS levels at the yellow arrows) and the head fake negative divergence (see relative price/MS levels at the red arrows).
The 60 min chart shows a positive and leading positive divergence at the end of June lows, then confirmation (green) and a large negative divergence at the head fake area.
The 30 min chart is more detailed, I highlighted dates as well with accumulation/distribution signals, the August area is leading negative.
The 15 min chart has even more detail showing a parabolic gap that was distributed (these are areas that offer excellent price levels to average out distribution), again a leading negative divergence around the head fake trend area.
The 5 min trend shows a decent accumulation area at extreme lows fro the trend, a relative divergence as price crosses the head fake trend line and that turns in to a stronger leading negative divergence.
The 3 min chart's trend shows more detail, especially interesting is the positive divergence right before the breakout to the head fake area and leading negative divergence or strong distribution once above that level. Like so many charts seen this week, the crossing of the head fake trendline shows very strong changes in the underlying accumulation/distribution.
Again, more confirmation of what appears to be a set up to push USO through a particular price level and then sell the price strength above that level with another leading negative divergence.
The 1 min trend doesn't show as much history, but the divergences are clear, no accumulation above the head fake trend line.
Here USO shows a small bullish close at the white arrow followed by what would be considered a confirmation/downside reversal candle, a bearish Engulfing candle at the orange arrow followed by a move below the head fake trend line.
I'm already short USO equities as well as September $35 puts. I have a little room to add to puts, I would consider doing so around the $36 level if possible. If you are interested in some short exposure to Energy via USO, this area seems fine to me if you are looking at an equity short which has some advantages over a leveraged long bear ETF. If you would be looking for a put position, I would try to get a better entry at higher prices as it reduces risk and gives you better probabilities, but I still would consider phasing in to such a trade to make sure you get some coverage as soon as possible and then leave room to add, this can be accomplished in 2. 3 or 4 entries (1/3, 1/2 or 1/4 entries).
Overall I do like USO short, right now I don't see a strong signal suggesting a significant move to the upside or above the recent highs. A head fake move above recent highs would almost certainly need a more well defined resistance area or a price pattern intraday such as a triangle.
Feel free to email me with any questions.
No comments:
Post a Comment