XOP – The Disconnect
Aug 8, 2017 Trading Blog
I belong to several trading chatrooms and each of them seem to have that one group of individuals that make the same trading mistake over and over again. The common theme is always a complete bewilderment at how a company can being doing something so fundamentally good, however the stock goes nowhere, or worse, goes down on good news.
I primarily trade energy stocks and have run across many people in the sector who are totally confused as to why the XOP and its components continue to decline despite a nice bump up in oil, great earnings reports and solid drilling and production reports. What these people just cannot seem to grasp is that a company and a stock are two totally different things. They make the mistake of thinking that one group is a mirror image or replica of the other when they definitely are not. They are controlled by two totally different groups with different needs, desires, timeframes and agendas. Companies are controlled by management, and how many times have we heard that management has absolutely no control over where or how the stock trades? Most management types have absolutely no clue how the stock market even works, much less how to control it.
Right now, this disconnect is very apparent in oil and gas stocks, however in time they will re-connect. If people would recognize the notion that a company and a stock are two different things, then the action in the XOP becomes a little easier to understand.
We had a huge run in energy in 2016, and now we are experiencing a retracement of that move. That retracement has a cause. At this point in time, the cause is stock related, not company related. Large traders, funds and institutions operate in cycles. They don’t enter all at once on the way up, and they don’t exit all at once on the way down. Additionally, each player or group enters and exits at different points. The stock moves when the pressure on one side becomes greater than the pressure on the opposing side. Right now, the sellers are still in control of the XOP and the components. Some are late getting out, some still have large positions to exit, and some just aren’t interested. On the opposing side, only a few want to get in right now, so therefore the slow drift down continues.
When a turning point is reached (and I think we are getting close) there is a very strange activity that occurs that really confuses many traders. That phase is the accumulation phase. Most traders always expect that “V” type turn, and sometimes it happens that way, but most times it does not. What normally happens is a grinding sideways action where the buying and selling pressure is somewhat equal, but is primarily controlled by the larger money. We get high volume lows of the accumulation range and low volume highs of the accumulation range. There are several “bull traps” that occur during this phase where all the traders leaning on oil price, earnings reports and drilling reports all get excited, and they all buy the false breakout, and they all get it wrong. It is usually identified as a false break due to the light volume. We recently had one of those up around 33.00. The cause of the false breakout isn’t company related, the cause is that the larger money doesn’t have their full position yet and they also don’t have a clear path to mark up the price to produce a profit on their investment.
There are also many traders who get it right and buy at the bottom within the accumulation range, but always get shaken right before the big move up. This is no accident, it is a planned move by larger forces who are trying to acquire stock and clear that mark up path to profit. Many people who are trying to “pick the bottom” are not seasoned traders, and therefore their confidence in their position is usually weak and their stop is very predictable. Right now, there are many people who may indeed have picked the bottom here in the 30-33 range, however almost all of those people will be shaken out on the coming move under the lows which will grab all their stops.
Right now, the disconnect between the companies and the stocks is a result of stock behavior, not company behavior. It is (if this is indeed the final bottom) caused by larger money acquiring positions at the right price and size, while eliminating all the weak holders and also trapping shorts. All this, happening at the same time, overcomes the action of the companies themselves and the underlying commodity.
It is fairly simple to know where we are in the company cycle, they tell us in detailed numbers and earnings reports, however it is much more difficult to know where we are in the stock cycle. At this point, I expect that an accumulation range is forming here around 30, but there is no guarantee that this is indeed the bottom. Be cautious, scale in slowly and give your stops plenty of room to avoid being picked by larger forces. And always keep in mind, a company is not the same thing as its stock. Good luck.