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Energy Sector Trading Plan November 19-23

The last six weeks have offered some great trading opportunities in the upstream E&P subsector of energy. Most of the opportunities have been on the short side, but the rips back to the upside have been pretty good too, if you can find the hidden demand levels in the XOP and/or individual stocks hitting larger timeframe demand.


Last week the XOP put in a retest of the 34 level which we first hit back on October 30. A big part of my trading background is formed by Wyckoff principles and I’m looking at October 30 as a possible selling climax. The bounce back to the 38 level was the Automatic Rally (AR) and this recent move last week was a secondary test of the October 30 climax. The question now is this: Does the original selling climax and the subsequent secondary test at 34 hold or does it break down? The big issue when trading Wyckoff principles is the constant decision as to whether a formation is an accumulation or a distribution. More simply, is the current action just a temporary range stop on a more prolonged distribution or is this 34 level a place where past distribution ended and is now switching over to larger timeframe accumulation?


Currently, we are very early in the formation of a trading range between 34 and 38. We held the bottom twice and now the market needs to show some type of rally back up to 38 in order for this current range to continue and create a larger cause or accumulation which could force the market to evolve into an upward trend back over 40.


This coming week should give us a couple pieces of information. First, do we move back down and test the 34 area again and does it hold? If it holds, then the bottom of the range strengthens and the case for this being an accumulation strengthens. If it breaks, then we wait to see what happens on the break and whether that break from fair value turns into a spring, indicating that sellers are exhausted and larger timeframe demand exists underneath the market. Second, do we avoid another test of 34 altogether and simply grind back toward the 36 level and how do we handle that midpoint level? It would be positive for longs if the XOP could make a move back to 36 this week, as that would show that there is at least a balance in supply/demand in this range indicating that a large number of market participants see fair value in this range. The best case for the longs would be a move all the way to 38 for a secondary test of the AR point, but I’m not sure we have enough volume on a holiday shortened week to make that happen.


Given last week’s action around the 34.50 level, I think there is some solid demand there. I could see the market possibly opening even Monday morning and going down to test the 34-34.50 area quickly, and then bouncing sharply back above that level toward 35. The market had every chance to break down last week, but there was some pretty serious buying Wednesday through Friday. I debated whether those three days were short covering or newly established longs, and the longer the week went on the more I leaned toward those being new longs. I think the higher odds play this week is for that 34.50 level to hold and produce a little run up past 35, possibly to 36.


If that 34.50 level doesn’t hold, we should get a quick test of the bottom of the range at 34. This should be a fairly light volume week, so I don’t really see that 34 level breaking on low volume, there just seems to be too much demand waiting there. Not saying it can’t happen, just that the odds suggest this is a low percentage occurrence. I definitely wouldn’t attempt to short any breakdown of 34 on a low volume move, as it could snap back very quickly trapping novice shorts, which could then flip to a short squeeze back toward 36. Bottom line is that I’m not shorting a breakdown. I might short the 36 level, but I really don’t have any motivation to short anything less than that and I definitely have no desire to get caught short on a stop hunt and reversal down at that 34 level.


One thing that pushes me toward the long side is the possibility that the recent moves have been more technical rather than fundamental. And by technical I’m not really referring to technical analysis, but rather the recent moves could have been caused by things that are not fundamentally based. I’ve seen a few fund blowups and read a good bit about the long crude/short natural gas trades that have been unwinding and I think that has some real influence on recent action. Those kinds of things can push markets much farther than fundamentals would suggest. If the market puts these technical events behind it and refocuses on fundamental data, we could get a big bounce. Basically, I think the market has overshot due to some one time off events not related to the fundamental market itself.


Trading Plan for Monday: So what is the likely best trade this week? First of all, I’m NOT playing large during a higher volatility, lower liquidity holiday week. I’m talking .25-.5% account risk sized trades. I’m happy to just make a little quick cash flow this week, not longer term 1-2% risk swing trades. I’m planning on getting long the XOP on any test and hold of that 34.50 level. I’d love something in the 34.25 area and would definitely go with bigger size if we got a test of the 34.00 area. I think we hold the 34-36 range most of the week and I’m happy to grab a little profit on that range.

What would I not like to see? I definitely don’t want to see a big gap up Monday morning. That would pretty much destroy my entire trading week. I have no desire to get long up over 35.25, as I just don’t see much profit potential before hitting supply overhead. I feel like we haven’t seen the last look at 34 and getting long a large distance from that level just isn’t good odds.

What would be the ideal setup for Monday? The ideal setup would be a large gap down into demand at 34. I’d buy that with both hands. If the market somehow does break down that 34 level then I’m happy to sit patiently since any position I’ll have will be a smallish one. If the market did somehow slide down toward 33, I’d have no problem adding to my position to turn it into a longer term swing trade. Please note that there is a difference between adding to a loser and adding to a position with a larger timeframe plan in mind.

Remember, these are just my notes, not recommendations, so prepare your own trading plan and trades using smart money management and risk control. Good luck this week and Happy Thanksgiving!



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