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Energy Outlook and Trading Plan for September 23-27

What an interesting week, I didn’t realize that it was possible for so many people to be so wrong over a single event. The mass media said it was a historical “world changing” event of terrorism and destruction that would dramatically change the energy sector and inject a huge “permanent risk premium” into the industry forever and ever.

And we gave it all up and closed as if the event never happened at all…

How did so many people get it so wrong? Are they just early (but still very, very wrong)? And how are those same people still beating the same dead horse a week later after the market has clearly told them that their opinion is wrong? I have no doubt those guys are waking up today on Sunday morning and checking Twitter for another headline, hoping. Not saying that they can’t be right if they stay solvent and hold on long enough, but as things exist NOW, the market is saying they are presently wrong. There’s a difference between your opinion of a situation and the market’s opinion of a situation. And the market is ALWAYS right.


I had last week’s trading plan pegged almost perfectly. I was looking for 26-27 on the news for a great short opportunity, and that’s exactly what we got. Unfortunately, I didn’t trade it very well and got greedy on my entry. I had planned on starting a scale at 26, but I got caught up in the media hype about how huge this event was and I pulled the plan and decided to wait for the overreaction and Tuesday gap up to 27, which didn’t happen. I made the classic mistake of letting someone else talk me out of my plan. It’s one of the worst mistakes you can make in trading. Always stick to your own view and NEVER let an outside influence cause you to do something outside the plan.


I love Twitter, it has gotten me through many boring trading days, but this week it was pure poison. At this point, I think Twitter may not be in the best interest of my trading. It’s entertainment, a distraction, nothing more. This entertaining distraction cost me a great trade this week and that just can’t happen again. I think the members of energy Twitter don’t realize what a closed loop microcosm of a system we live in on this platform. It becomes an echo chamber of so called ‘experts’, very few of which actually trade real money. Most of these people don’t realize the difference between real world events and the market’s perception of those events. When you live in this loop daily, you start to think energy Twitter IS the market, well it isn’t. There’s a whole world and market out there and this week clearly showed that neither of them cared one bit about the ‘world changing’ events in out little loop. It all comes back to the fact that if you want to trade and not become part of the herd, then you have to think for yourself. I slipped and didn’t do that, and it cost me.


So having made that mistake, where do we go from here? Common sense would say that the market has spoken and the message delivered was clearly that E&P stocks are still sick and broken. As I wrote last in last week’s plan, the shale companies just don’t move based on the factors that used to move them. Geopolitical premium isn’t the game anymore, things have changed and shale has it’s own set of unique drivers, many of which aren’t oil price related. I’m sure there will be follow up headlines and we will see more spikes, but the bigger picture seems to be saying that while these little waves up may happen periodically, the larger tide is still down. I don’t know how far down the bottom is from here, but I think it may be further down than many people are expecting. The only thing that pulls energy out of this decline is a China deal, more attacks that are exponentially more destructive or an all out war. And even if those do happen, they may not overcome the larger negative of an approaching recession and falling energy demand. This, or course, is all just my opinion, but this past week was about as clear of a signal as the market could have given that the sector is still not ready to turn. Maybe that changes, maybe it doesn’t, all you can trade on is what is happening NOW and what the market is telling you NOW. Doing anything else is just wishing and guessing.


One other point about oil price, this latest spike up was a golden opportunity for E&P’s to put on some great hedges and I’m sure many did. The problem with those hedges is that it allows them to keep ramping up production with price protection. More oil supply isn’t what price needs right now and this hedge opportunity may lead to a supply related price cap in oil. I know the rig count dropped big, but it’s the total production you want to keep an eye on. All those DUC’s are out there just waiting to be completed.


This week’s trading plan: I know after reading all the above that you probably expect me to say short the hell out of everything energy related, but the early part of the week may actually offer some quick and attractive long trades. The biggest point of interest for me this week is the ~22.68 area. The XOP formed a nice little base for the month of August which probed that area several times before breaking through and it should drop down and retest that area. Will there still be demand willing to defend that area? I don’t know, but it definitely offers a nice risk/reward proposition to find out. If it fails, you will probably know it by any dip under 22, so the risk is about 75 cents. If it does hit bottom around ~22.68, then I think we make at least one attempt to get back into last week’s range somewhere in the 24-24.50 area, which is about $1.75 worth of profit, so the payoff on the trade is about 2.3:1.


But let me throw one conspiracy theory out there first. What if the August base was caused by big money who had decent information that some type of attack was possibly on the horizon at some point? That month long base accumulated enough stock to produce about a $2 run up in price, we instead got $3.50. Was the continuous decline last week all those August accumulators slowly taking profits?? If it wasn’t them taking profits, then who could have possibly been doing all that selling directly into the face of  incredible geopolitical risk?? Just a little something to think about.


There are also related markets that are offering energy clues. I wrote about the XRT and IWM approaching important levels last week. The XRT completely rolled over from 44 down under 42. That’s a measure of retail and consumer spending. That’s one of the best recession measures out there. The other economic health measure is the index of small domestic companies represented by the IWM. It was sitting right at a breakout point at ~159, but it also faded all week down toward 155. Neither of these recession linked items made any effort at all to break out. Keep an eye on those two this week and see if they make any attempt to break out or if they simply continue to fade with energy.


If there isn’t an XOP pullback and/or the long trade doesn’t materialize, then I will be sitting on the sidelines evaluating the next run up and planning another short trade. XOP has already dropped about 10% from the 26 top and I don’t see much reason to be short down in the 23.50 area, as the risk/reward is terrible. One headline could completely blow you out of the water and the reward on the trade is minimal. Taking a short at 23.50 probably exposes you to $2 of risk with less than $1 of reward – not good odds at all and not a bet worth taking. There should be a clear signal on the next approach and test of 26. It would be a great risk/reward spot for a trade, but the better play might be to let it break through and test the 27-28 area up around the 200 day moving average (which is also a decent liquidity gap from May and the two low points in February and March). 26 and 27.50 will probably both be good spots to put on a short.


One other idea on a short up in the 26-28 range, all the existing shorts over the last couple of months got cleared out last week. There probably isn’t anyone short energy right now after the clear trendline break which was followed by the geopolitical gap up. It’s very doubtful that shorts rode that situation out by holding. Their stops were probably all triggered, which was a big part of the gap up. Eventually, all those shorts will return to the sector, which likely caps out any profit potential on the long side. The last couple of weeks used up a lot of buying power with shorts covering their positions. That’s a great deal of buying gone and a great deal of angry shorts ready to do it all again.


The Twitter crowd will continue to beat the same dead horse this week, so be careful. If the market shows any signs of moving up, their chatter will get louder as they become more convinced that their opinion was right all along and that they were just “early”. There’s a good chance they get proven wrong a second time. But as always, this is a market of irrational humans we are dealing with, so anything can happen, from 28 to 20 on the XOP. At this point, nothing would really surprise me. Good luck this week and remember that stops are your best friend.


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