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Weekly Energy Equities Review, Market Outlook and Trading Plan for March 8-12

The big question in last week’s article was whether this market move down, which started back on February 9, was simply a pullback before the final blowoff leg to the upside, or if it was the start of a longer term move down. After last week’s action, I’m still not sure. I think this week is going to answer that question though and will likely set the market on a directional path for the next 3-4 weeks. Friday’s big recovery suggests that the odds point to a move up to test the highs, where the decision will be made. I think this could possibly be one of the most important trading weeks for this entire year.


I’m 100% in cash and probably going to take it slow this week and stay on the sideline until the market tells me which way it’s going. Even though I’m a very short term trader, I don’t like trading this kind of volatility, especially in a market which could be at a major turning point and is running on emotion, momentum and FED pumping. I’m more suited to a smoother, slower, more organic and fundamentally based movement where I can easily control my risk. In this kind of market, at this kind of topping area, controlling risk is almost impossible. There are three positions when it comes to trading: long, short or in cash. There’s no harm in sitting it out, letting the market settle back into a comfortable volatility level, and then getting back to what you do best as a trader. Also, I’ll probably be off Twitter this week. It seems my market view is very different than almost everyone else right now, and it doesn’t help to be bombarded by a constant flow of adverse opinions. I think we are in that euphoric stage that occurs toward the end of a bull market and I don’t want to get caught up in that bullish euphoria, so the best solution is to avoid it.


SPY – The level to watch this week is 370-372. Last week I pointed out the 371 VWAP from October 30 and the SPY went almost exactly to it and turned in Friday’s big reversal. The bounce did reclaim the current week’s VWAP around 382, but it failed to reclaim last week’s VWAP up at 385. That tells me that the buyers are still in control of this market, but the bears did throw a pretty good punch and things may be more equal than it seems. The key now is to see what happens as the bulls try to take it back to the highs in that 392-394 area. If the bears step up there, or at any point before there, then this market could easily top out and roll over. The demand point to watch Monday is 380-382. If demand steps in there, then we probably get a move at the highs. The market will show its hand this week and a decision will be made regarding the environment for the next couple months. Just have to be patient and listen to what the market has to say.


QQQ – I think tech is still in trouble. It broke that October 30 VWAP around 311, but couldn’t quite manage to reclaim it on Friday, closing at 309. The QQQ is now sitting right where it opened the year, which had been a fairly defined support level since January 4. If you go back to the September – December period, that 300 level acted as resistance for several months. Price broke out from that level in December and this week price dropped right to that breakout level which was prior resistance, does it now act as support for the longer term? On the shorter term, price broke below that support level from January 4 and could only manage a bounce back up to it. Does that January 4 support level now turn into resistance? There are a lot of good road signs in QQQ and it’s just a matter of listening to what those signs tell you as price explores them.

The QQQ also failed to get above the current week’s VWAP of 310 on Friday’s close. It also closed well below last week’s VWAP, which tells me that sellers are clearly in control in tech, much more so than in the SPY. The big levels this week on the upside are 310-313 and 324-325. On the downside, last week’s 297 is the point to watch. The big signal to me will come at that 324-326 area. A clear rejection there could signal a top and new downtrend. I’d be surprised if the QQQ could manage any run at the highs around 338 this week.


IWM – The biggest market signal for me will come from the IWM this week, specifically that 226-230 area. The IWM managed to stay well above that October 30 VWAP, unlike the SPY and QQQ. Small  caps are where the strength is in this market right now. Does that strength continue and do small caps lead to the upside? The IWM is in a very well defined trend right now which began back on February 9. It has tested about eight times on that downward channel and bounced almost perfectly off of it on Friday. That bounce took it right back to the center of that trend channel and exactly back to the current week’s VWAP, which seems to suggest that things ended in a tie this week between the bulls and bears. The upper edge sits right near that important 226 area.

I’m watching 215 on Monday for a signal that demand is still under this market. If 215 gets tested and holds, then I expect that price will make a run at that 226 level for a huge gut check. If there is a clear rejection there, then I expect a major pullback, possibly as far as 180. However, as I’ve been saying for a few weeks, I really think we are going to get one final blowoff move to the upside before the bull dies. I could easily see the IWM taking out 230 (with a possible long trade) for a quick run to 245-250, where I’ll seriously consider getting short for one of my bigger trades of the year.


TLT – The really curious thing about Friday’s stock market volatility was that nothing else moved with it. It was strictly an equity temper tantrum. On Friday, TLT, UUP and GLD were basically flat as stocks gyrated wildly. That suggests that Friday’s action really had nothing to do with the macro picture. Since the macro picture wasn’t involved, that further suggests that the late week volatility in stocks was probably a temporary thing. See if that continues this week. As for rates themselves, they seemed to settle in this week, at least stopping the freefall. If they do find a base here, I would expect that would bolster the equity markets and send them higher. As I said last week, rates don’t have to go down to make equity markets happy, they just need to stop going up. Technically, I like the action in TLT as it had a high volume selling climax last week in the 137 area, however the retest of that area held this week, but the most encouraging thing was that the retest was on much lower volume. This suggests the bottom may be in for awhile in TLT.


UUP, GLD, GDX – This was an extremely frustrating part of the macro picture for me last week. I’ve been patiently waiting for the long GDX play, however it refuses to move to my entry point. I got exactly what I wanted with the dollar (UUP) as it moved up sharply. That sharp move up should have produced a flush in GLD, and subsequently a nice move down in GDX for a long entry. However, the dollar moved up, yet GLD stayed flat, and GDX actually went up! While the moves didn’t help my trade setup, they do strongly indicate that the theory of the trade is correct. The dollar move should have sent GLD/GDX down, but there was so much demand there that it wouldn’t budge. That suggests that there are many people thinking just like me on this trade wanting to get long. I’m going to be patient with this trade setup, because the current demand could vanish once they are filled. GDX could get one final shakeout move to the downside before the next move up. Our advantage as small traders is that we can get filled in that shakeout,  while the bigger players had to build their position in the thicker 31 area where they could find liquidity. I’ll be interested in any move below 30.50 to start a scale in long, probably in four pieces.


Energy XLE, XOP, USO

What can you say about energy? As the market moves down sharply, energy stays green. The only signal you can draw from that relative strength is that there’s huge demand underneath and that there’s probably a nice move up coming. The key for XLE, as it was at the 46-48 level, is how much supply remains in the 54-55 level? The XLE had way above average volume on Thursday and Friday as it grinded into that supply area. Will that supply back away from the market and try to draw buyers upward? Does that supply panic and come down on the market if the SPY does top out? It’s all unknown at this point, but one thing is for sure, you don’t want to step in front of this momentum. I had planned on a short here at 54-55, but not going to do it. There’s just too much momentum. Now, whether that momentum is correct or not is a totally different question. There will be a prime shorting opportunity, but it’s not now. I think this sector could blowoff with the IWM, in which case I could  get a juicy short opportunity on any breakout of 55.


I think the reason I remain bearish on energy up at these levels is that I’ve followed this sector for years. When you follow something that long, I think you develop an intuitive sense of what things are truly worth. Traders just coming to the sector don’t have that longer term view and the resulting intuition/feel. With a longer term view, you know when things are bad, you know when things are good. You know when true fundamentals are driving the sector and you also know when momentum is driving the sector. I compare these companies to different points in time over the last ten years and sometimes the valuations don’t make sense when measured against the longer term average. We were in one of those times last summer and we are in one of those times right now.


Yes, momentum plays are fun (and profitable), but the issue I have right now with energy, and the rest of the market for that matter, is that it is wildly disconnected from the fundamentals. This week’s OPEC meeting was a prime example of why I want nothing to do with energy on the long side right now. OPEC actually extended cuts. WHY? Have they simply become oil’s version of the FED? Why would you extend cuts if demand was supposedly so great? Why would you extend cuts if supply were running tight? You wouldn’t. It’s simply paper price manipulation. And like I said, while that might be fun to play, it doesn’t last and it can usually breakdown very quickly when you least expect it. When the game is over, everyone rushes for the exit at the same time, and that makes controlling risk almost impossible. There’s just something that isn’t right with the sector right now. It’s stretched away from the longer term norm and while there might be some money to be made in chasing that extension, the real danger is in the regression to the mean. I’d be willing to maybe chase a move based on true fundamental supply/demand factors, but I want no part of chasing something that is based on an OPEC pump and dump.


How long can OPEC manipulate price when there’s really no demand and plenty of supply? Did price reach 65 on manipulation or on fundamentals? Look, I know everyone is expecting demand to return, but so far it hasn’t. What happens to oil price if the returning demand doesn’t materialize? The supply is still there. These energy names are expecting perfection, and they are priced for it, as is oil. The individual companies are still bad businesses staring right into a green energy future. They still have huge debt, bad management, burdensome dividends and limited cashflow. The worst part though is that they have burned through their prime acreage, so they definitely don’t have the future resources they used to have.  All those things leave only disappointment and a quick trip back down. I could be wrong though and things can always be manipulated much further than most think, but I just see no reason to take the risk when there are better opportunities elsewhere. The much better play is a short when things spike upward to ridiculous levels, as they always seem to do lately.


The real key right now with respect to energy, is that you have to distinguish emotion, momentum and manipulation from the true fundamentals. If you buy these without knowing why they are currently running, you leave yourself exposed when they turn. I don’t think these are fundamentally good businesses right now, they just find themselves getting swept along in a raging bull market (which might be about to top) that is running on pure emotion, FED money and OPEC manipulation. Fast money is chasing the reflation trade, OPEC is throwing gas on the fire and retail is piling in on the chase. The best reason many can give for this energy run is that energy “has to catch up with the rest of the market”. In essence, what most are doing is chasing a lagging industry hoping it outperforms in the short term because it has been so bad in the longer term. It’s buying longer term relative weakness, and that’s not a great strategy. Will many get lucky and make some money chasing the momentum? Sure. But many will also give it all back and more when they don’t realize when the market has changed. They think they have bought quality companies, when in fact all they have done is buy wild momentum caused by a manipulated oil price.


And if all the fundamental information and OPEC manipulation weren’t enough to make a bearish case, there’s still the technical picture. I’ve posted on this a few times on Twitter so there’s really no reason to go in depth on it again. Basically, if you look at the longer term ten year weekly chart, XLE is running right into a major supply level. Do you really want to buy into a major supply level after a 100% run, with an overall market that might be topping? Not good odds at all. I’m not saying a long trade can’t work here, I’m just saying that the odds of success aren’t really high enough to support long term profit if you took this trade 1000 times. In sports betting terms, what you are doing here is betting Kershaw and the Dodgers at -400 odds. Yes, you are probably going to win that bet 75% of the time, but do you really make any money from it over the long term? No, because the play is too expensive and you have to basically hit it 80% of the time to break even. So while the bet (XLE long) looks enticing in the immediate term, the longer term odds don’t support it as being profitable. Basically, the wins end up being fairly small, while the losses end up being very large. Wish I knew a better way to explain it, but that’s the best I can do.


Ok, enough of the bearish bias. I just wanted to express why I’m not in on this long energy momentum trade. Am I missing some upside? Yes. Do I care? No. I’m in protect mode right now with regard to energy and patiently waiting on the opportunity on the short side. I’ll be trading other sectors while I wait. Sorry for the negative slant, but I always offer you guys my true opinion without sugar coating, even if it is very different than the overall common Twitter market opinion. Am I right? Who knows. But trading isn’t about being right, it’s about protecting what you have, avoiding negative expectation trades and controlling risk. Sometimes opportunity is just too expensive. I’ll wait on energy.


Trading Plan for the Week – The primary watches for this week are IWM and GDX. I’m waiting on a washout in GDX to start a scale in for a long trade. I’d like to start that scale at 30.50 with adds roughly every 50 cents down to the 28 area. In IWM, I’m looking for a long play if demand shows up in the 214-215 area. I’m also willing to play a breakout above 227 for a ride to 230 and possibly a blowoff move up to 245. However, the big trade for me in IWM is a short up around 245-250. I think the market is in that final euphoric stage, and if it is I want to take advantage with very large short bet up there.


As for XLE, I’m on the sideline this week. I’ll be watching to see how it handles the 54-55 area. If I were to get long (which I probably won’t), there will be a trade on the 54-55 breakout as it spikes up and then falls back down to test the breakout area. If price runs up toward 56-57 and then drifts back down to 54-55 on very low volume, I might make a long play using a very tight 53.50 as a stop. However, my primary watch is for a simultaneous blowoff spike in IWM and XLE for short plays in both. I think the top area in IWM should be around 245-250 and I think that might produce something around 60-62 in XLE. I’m also interested in a short in USO if this parabolic run continues. I’ve already covered how I feel about the OPEC manipulation, let’s just say if the market really gets crazy here I’d have no problem moving in on USO short if the price is right.


As you can see, most of my trades this week are longer term plays, so I’ll probably be on the sideline letting the setups form. I’ll also be fairly scarce on Twitter, as I’m really trying to avoid being bombarded by the herd’s bullish opinion. I’m looking for the short opportunity and I don’t want anything interfering with that play. Good luck this week, it’s definitely going to be an interesting one. Now it’s off to the winery for a couple bottles, some live music and an afternoon with the love of my life. Get out there and enjoy the rest of your weekend.


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