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Weekly Energy Equities Outlook and Trading Plan for January 21-24

It was another slow week in the energy sector, but sometimes that’s not a bad thing. In last week’s post, I pointed out that 22.68 was going to be a very important level in the XOP, and that turned out to be true. Monday’s low was exactly 22.68, Tuesday’s low was 22.71, Wednesday’s low was 22.67 and Thursday’s low was 22.73. That important level held for almost the entire week before failing on Friday. There was some demand at that level, but unfortunately it all got filled and the sellers took control on Friday. Now the question for this week becomes: Will the demand show up and reclaim that 22.68 level or do the sellers take further control and push this market down to 21.55?


As for Friday’s action, it was extremely discouraging for the bulls. SLB came out with earnings premarket Friday and it seemed like the market initially liked what they heard and sent SLB near 40, however the SLB sellers immediately took control, and they did it on fairly heavy volume. Surprisingly, HAL and BKR didn’t follow and finished green for the day. While SLB is a services name and not an E&P, that earnings report probably should have bounced the entire sector off that 22.68 level, but instead it was ignored. Also, on Friday SPY gapped up huge to new highs and held them all day, yet XOP finished at the lows of the day. The relative weakness is concerning to say the least.


Once XOP broke 22.68, it was an all day grind down bottoming at 22.33 and closing near the lows of the day at 22.37. XOP got within 5 cents of the 50 day moving average which stands at 22.28. I had 22.20 as my next level in last week’s post, which is the 50% retracement level of the December run from ~20. The bulls should try to make a stand at 22.20 on Tuesday. If that level holds, the bounce will be important to evaluate. If the bounce can’t clear 22.68, this thing probably tanks. If demand shows up in a big way and price can clear 22.68, we could be headed back up to test the 24 level.


XOM and CVX are still not showing any leadership. XOM closed the week at 68.56 and CVX closed at 115.58. Both finished near the lows for the week and that’s very discouraging, especially since both are big components of the DOW/DIA, which was just ripping up. This kind of extreme relative weakness of the two major players in the sector just can’t be ignored. The only thing that was encouraging to me was that the largest E&P’s like COP, OXY, EOG, PXD and CXO all looked better than the majors this week.


The real problem for the XOP was the smaller cap trash companies which are weighted equally to the majors and larger E&P’s. That’s the danger of an equal weighted index. Many of those smaller names really took a beating this week, especially the smaller natural gas names. That trash group of WLL, OAS, LPI, CPE, etc. has just been a huge drag on the XOP. I bet nobody realizes that WLL has a 2.35% weighting in the XOP, while XOM has a 2.34% weighting. CVX checks in at 2.33%. RRC has a 2.39% weighting in the XOP, and it was down 9% Friday. It only takes one of these trash companies to wipe out the changes of the top sector giants. Know what you are trading when you step into something like XOP.


Another concern was the refiners. VLO, MPC, PSX, HFC and PBF all had a very bad week and that had a hidden negative effect on the XOP. During the fourth quarter of 2019, refiners held the top 6 positions as the largest holdings in the XOP, reaching a total holding of about 18%, if I recall correctly. They are down to ~13% total holdings this week, but still have a huge effect on the XOP. Perhaps the refining component is also what  is weighing on XOM and CVX and the reason why the pure E&P’s are outperforming the majors. Those huge EIA builds in products might be about to catch up with the refiners and cause problems. The actual commodity, WTI, also had a rough week dropping back and closing below 59. Just too much supply. The addition of 15 oil and gas rigs this week didn’t help either. If demand starts to dip or the economy starts to slow, oil could really tumble. I’m watching the 55 level in the coming weeks.


Overall Market View

It was another week of parabolic action in SPY and QQQ, while IWM finally decided to join the party. I had one of my best daytrading weeks in a long time with the IWM. Every morning provided a nice entry and it was just a matter of riding the wave all day and not getting shaken out too early. As I’ve posted many times, IWM and energy stocks are very similar in that they are sensitive to the domestic US economy and consumer. The action in IWM and XOP diverged most of the week, but was similar on Friday. IWM topped out, put in a reversal and finished at the lows of the day, just as XOP did. They both showed extreme relative weakness to the SPY/QQQ pair. I’m not sure if this is a sign of things to come with real economy weakness possibly showing soon. It will be interesting to see if IWM can regain its upward momentum next week and test that ~174 level, possibly pulling energy stocks with it.


It would be extremely concerning to see IWM stall at that August 2018 level and put in a double top, especially if SPY and QQQ climax at the same time. The issue for me is whether the money flowing to small caps is based on real anticipation that the economy is going to get stronger OR if this money is just fast money chasing an underperforming sector for quick gains. This was the same kind of concern I had with the December run in XOP, was it real belief or just fast money manipulation? I guess we will find out in the next couple of weeks, but until then you have to believe that the trend is up and keep riding that wave. Getting short right now just isn’t an option, at least not for me anyway. I keep seeing guys trying to guess the top and they keep getting steamrolled. Just don’t do it. The market will give you plenty of time to get short when the time is right. I’m not saying that this market can’t go down from here, but rather the odds and payout on that trade just don’t present a very good combination for making money… yet.


I mentioned this in last week’s post, but I’m looking for the buying climax in SPY and QQQ soon, if we aren’t in a stealth climax already. The pattern has been progressing for the last couple of months. There’s no telling where it finally tops, but once it does, you immediately want to start looking for a distribution pattern. The longer I watch this, the greater feeling I get that this run is being manufactured to take the market up as high as possible so that the current holders can start unloading, or at least have that option if things turn sour. I think the presidential election might have something to do with this approach and I’m starting to get the feeling that a Trump win isn’t the sure thing it was a few months ago, therefore a high level distribution gives major holders an escape hatch if the election doesn’t have the outcome they desire. The public is being whipped into a frenzy right now and FOMO is spiraling upward. The anxiety of missing out is getting unbearable for most, and that’s usually when the distribution starts. As the old saying goes, “When the ducks are quacking, you have to feed them”.  Just be on the lookout for the distribution possibility once you see that defined climax.


This Week’s Trading Plan

You guys all know I’m bearish right now on energy, but this week’s plan is probably going to throw you off a little bit. My primary plays this week are going to be a pair of long setups.


The first long setup will be an XOP play on Tuesday (market closed Monday). I think this market will drop down and test that 50% retracement area at 22.20, possibly 22.00 and then try a bounce back to the top of the range near 22.68. I want to get an entry as close to 22 as possible and I’m willing to give this bounce a try with a VERY tight stop. I’m looking to risk 20 cents to try and capture a 60 cent move, and possibly turn it into a huge trade if XOP can take out 22.68 and squeeze toward 24. While the 3:1 odds are attractive, it’s the implied odds and home run potential of the 22.68 break that really makes this trade worth taking. I think the winning percentage odds are fairly low that this trade actually works, but the payout odds are positive expectancy and just too good to pass up.


If the market gaps down big or starts screaming to the downside on Tuesday, cutting through the 50 day ma and 50% retracement area with ease, I’ll probably wait for my second long setup to play out. If XOP takes out 22 with ease, it’s probably headed for the 21.68-21.55 area which was important from December 12-13. That area has been the middle of the range (fair value and POC) for the last six months. It was originally established back in August when OPEC started intervening in oil. That 21.55 point is the last stand for the bulls. They either save it there or it very likely is headed for new lows and a complete washout. I’m willing to give a long trade a play off of 21.55 for a bounce. I don’t plan on giving this one more than 20 cents of risk either (about a 1% drop from entry). The action at 21.55 may not last long and the direction on a break or bounce could be sharp. This is NOT a trade you want to take if you have trouble holding your stops. If this trade goes bad, it’s really going to go bad, so USE STOPS. I’d look for any bounce to at least test 22.20 and possibly 22.68 if it really gets some demand behind it. It also has the potential for a home run on a 22.68 break, but the realistic chances are probably smaller on this second setup.


I’m sure most of you are probably thinking I’m bearish and why not just go short? Because I don’t see any good setups short and because all the surprises in this market have been to the upside. It has evolved into one of those situations where the likely path is down, BUT the payout odds just don’t give you what you need to make a short play worthwhile, especially with looming landmines on such things as Iran. Who knows where the next landmine explodes, maybe it’s Iran, maybe elsewhere in the ME, maybe even here on US soil. I just never put myself in a spot where I’m risking more than I stand to gain. I’d rather be a trader who loses >50% of his trades, but makes twice as much on the winners as on the losers. I see so many people trying to win every trade and they totally ignore the payout on those trades. They incur large losses and small wins, and eventually go broke.  Yes, getting short probably has a greater than 50% chance of being the right direction, but are the payout odds worth it? I don’t currently think so. Maybe in the future that changes, but right now I have no desire to get short down here.


Last week’s post got way too long, so I’m going to cut it off here this holiday shortened week. Hope you all enjoy the Monday holiday. I’m still on my self-imposed Twitter ban, but I do check it each night for a few minutes, so feel free to DM me @oilstocktrader if you have questions or comments.


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