Weekly Energy Equities Review, Market Outlook and Trading Plan for March 1-5

The market finally started some type of pullback, however it remains to be seen if this is just a little pause before what I think is the final blowoff run or if the market has already topped and we’re on the way down. My recent bearish bias has been borne out of this run that originated in November. It just has that “late bull” feeling to it and I really think the end is near, likely within the next few months. I’d be really surprised if this bull market continued for longer than six months, especially when it runs into the next September/October period. The market is running on incredible liquidity, relief packages, stimulus, free FED money, zero rates, etc. It’s probably 2 a.m. and the party is in full swing, but it doesn’t last forever, and someone is going to get stuck cleaning up this mess. I don’t want you guys to think I’m some crazy permabear, but after 22 years of trading, I’ve been mauled by a few. It’s never fun and the worst part is that it happens before you ever see it coming. More like quicksand rather than an all out attack I’d say. But enough of the bearish buzzkill, the only thing I can really say is be responsible, manage your money and protect yourself best you can. On to the macro picture.

 

SPY – The price failure Wednesday afternoon was significant. The 392-393 area will be a difficult level to recapture. I think it was the force and speed with which the rejection was created that was most important. It had the feel of an upthrust pattern that got rejected before it was able to complete. It’s like traders were trying to take it up quickly, pick the stops and establish short positions before the fall but there was so much supply that they couldn’t manage it. Nothing newsworthy occurred after the close Wednesday, yet the bears were out in full force from the opening bell on Thursday, as they took it from 392 all the way to 378. Many of the recent pullbacks have simply been buyers pulling back, but this one was different, it was heavy selling volume and there really weren’t enough bids to absorb it. The volume on Thursday and Friday was significantly above average, as were the daily ranges. Those two things tell me that this was active selling. Someone wanted out, maybe some kind of rebalancing month end or maybe true selling. It will be interesting to see if that group shows up on Monday morning.

 

There’s a VWAP in SPY which started back on October 30 which represents this entire bullish leg (the one that has turned me a bit bearish). That VWAP is currently at 371, so that’s going to be an important point if this pullback continues. If price drops below that level and starts to establish, that suggests that this might be an extended move down, both in points and time. To even give back a quarter of this run off the March bottom would take the SPY down to the 355 area, which would be right back to where it was on the November 9 vaccine announcement. That 355 would be an important decision point in the larger picture. I don’t want to get too far into the future, but the 325-350 area could be a potential target on the coming SPY pullback.

 

QQQ – Tech was simply a disaster this week, but there was one good thing which I don’t think many noticed. As with the SPY, there is a VWAP from October 30 in QQQ which sits at 310. The QQQ bottomed three separate days in the 311 range. Watch the 308-310 level on Monday. There’s also an uptrend line near there from the March lows. If price establishes below 308, there is probably more downside to the 292-295 area. Any drop below 292 could open up 263-266. I doubt that happens, but that’s where the levels are. QQQ is trading in correlation with rates right now. If the TLT can stabilize next week, there’s a good chance QQQ holds that 310 VWAP and makes a nice recovery, much like it did in September and again in October. One other point, QQQ has been trading inversely with IWM, so watch that correlation. If QQQ recovers, that could signal a further pullback in IWM, or at least some sluggishness, which wouldn’t be a good thing for XLF and XLE.

 

IWM – Much like the SPY, the IWM had a major rejection in the 226.50 area on Wednesday afternoon which led to a selloff down to 215. I really think there still might be a bullish blowoff leg coming in IWM to the 245-250 area, but the action on Thursday and Friday was definitely concerning. Small caps will have to defend the 215-216 area early in the week or there could be a pullback coming that could take it to the 200-205 area. The October 30 VWAP for IWM sits at 198. As I posted last week on Twitter, I’m looking for something to play long for the blowoff  top and IWM is probably going to be my chosen vehicle. I’ll be watching that 215 area on Monday and if it looks like it’s going to hold, I may start building a long position for a ride to 245, however it’s going to have a very tight stop on it and may take a couple of tries. Size appropriately.

 

TLT – It was a wild week in TLT, just an absolute freefall down to the 137 area. As I’ve written the last few weeks, it’s probably inevitable that equities finally get concerned with rising rates, and we saw that last week. Was that 137 level the tipping point for equities? If equities are going to recover, the TLT needs to establish a bottom. I don’t think it really has to bounce higher, as just establishing a base would probably be enough to soothe the equity markets. Rates don’t need to start going down, they simply just need to stop going up. The perfect scenario would be a big bounce in the TLT (lower rates), as that would probably send SPY and TLT moving in the same direction for awhile. If rates start to slide back down, that could be the force that propels the final blowoff leg to the upside in equities. It would be a Goldilocks situation.

 

GLD/GDX – As the TLT continues to fall, so too does GLD. The two have been moving together since August of last year and the correlation remains in the bigger picture. As with most market correlations, as you drop to smaller timeframes, there’s less exact correlations. Almost all of the correlations I work with are on daily charts. While the TLT may well correlated with GLD, the more important correlation for gold right now is the UUP. They diverged sharply on Thursday and Friday with the dollar finding a bottom and gold breaking down below some significant support. The real question now, and the basis of my GDX trade, is whether this is a major pivot point in UUP or simply a small bounce in the dollar that washes out the stops in GLD/GDX and leads to a leg up for gold once the dollar fades again. Over the past few articles, I’ve been predicting the dollar bounce. As commodities rally and interest rates follow them up, it’s really inevitable that the dollar would bounce. It’s simply money flow to the highest yielding currencies around the world. As rates rise in the US, money will chase that yield, thereby causing the dollar to move upward. Someone was buying bonds Thursday and Friday, and they need/demand dollars to do that buying with. But like I said, the real key is whether this is a bigger trend turn to the upside or just a little bounce before continuing down. Plan for the former, hope for the latter on the GDX trade. I know I’ve said this a couple times, but if you take this GDX trade, be very careful. It’s a fairly risky trade because it’s somewhat countertrend, definitely a scale in and not a plunge. In fact, it may turn out that there’s actually no trade there at all if the reflation trade is stopped cold by rising rates and a rising dollar. This entire trade depends on the speed of change in the UUP, TLT, SPY and GLD.

 

UUP – I pointed out the 24.30 level, which established in early January, a few times earlier in the week and price did manage to drop just below that, however there was a huge bounce off that level on Thursday and Friday. The bounce took the UUP from 24.17 all the way to 24.52, which is a significant move in that instrument. The correlation between the dollar bounce and equities selling off should be a wakeup call. I don’t think traders are focusing enough on the dollar and the damage that could result if it snaps sharply back to the upside. The dollar is sending a signal in the larger macro picture, but I don’t think anyone is listening yet. The hardest hit group in a dollar bounce would most likely be the commodity stocks. They have been driven by the reflation trade, however a stronger dollar (and higher rates) are the forces that will eventually stop that reflation trade and limit the upside in inflation. If you want examples of this on the larger scale, just go back and study inflation in the 1970’s and the forces that finally brought that under control. This rate issue is a battle between free market forces and the FED, and this week I think equities might be considering that the FED could lose this battle and higher rates (and QT) could be on the way earlier than expected. Keep and eye on the CAD specifically for signs of change in oil. I posted a CAD chart on Twitter showing the long downtrend that may be in danger of breaking. If that downtrend breaks, that’s probably not a positive for the energy sector. A weak dollar has been propelling this run higher in oil and if the dollar finds a bottom and starts to strengthen, that’s a warning that USO could be hitting a top and begin to weaken. Every piece of information helps.

 

XLF – One sector that loves higher rates is XLF. As interest rates rise, so does the interest income for banks. This correlation was on full display Thursday and Friday. As TLT bounced sharply, the XLF topped out and had high volume down days, losing about 5% in just two days. If the TLT continues to bounce, financials could continue to pull back. This is an important signal for energy traders. The XLF/KRE have been moving in sync with XLE/XOP and IWM. If banks and energy start to diverge, that’s a red flag for energy. Keep an eye on the financials and see where they find some support. Also, notice if financials start to diverge at all from TLT. Also, one other sector that can sometimes offer clues on rates is the XLU. When rates move up, utilities usually move down, which was the case on Thursday and Friday. Every clue helps in the bigger picture.

 

Energy XLE, XOP

The macro picture above was not kind to energy this week, but all things considered, it held up pretty well and could still have room to make a run at the 54 level if equities can turn upward again. The XLE is still in an uptrend and was probably even a few points above that uptrend this week. There’s a bit of an upward sloping channel that started back in early November (starting with the vaccine announcement) that runs around 47 on the topside and 42 on the bottom. Price is still above that top uptrend channel, even with the larger equity markets selling off. That’s a strong relative strength signal and the factor that makes me think there’s more upside to 54 left in this latest emotion based run. As for whether the actual fundamentals support this latest run, I still don’t think they do, but when emotion and momentum are in control weird things happen. I think these oil stocks are way overvalued right now, but that’s just my personal opinion. I’ve said this a few times, but this is purely a reflation trade being driven by fast money looking for quick profits. It’s very doubtful that what we are seeing now in XLE is being driven by long term holders. And when fast money decides the party is over, the fall can be blindingly quick. It’s extremely important to know why you are buying these oil stocks. Either you are chasing emotional momentum OR you truly believe in the future of these companies. Are you chasing a temporary, fast money, flavor of the day reflation trade or investing in the long term fundamentals of the oil industry?  Don’t confuse the two.

 

Let me clear up one thing though. I’m a fairly short term trader. There’s going to be ranges in the XLE where I’m completely wrong, as I was in that 46-48 area. I thought there would be more supply there than there was, however demand chewed through it more easily than thought.  Momentum is a difficult thing to estimate sometimes. I missed a little play in that area, but really not that much. However, once you see that you are wrong, you have to get back on the right side of the market. As you can tell from most of my posts this week, I’m moving a little more bullish on the XLE, simply due to the amount of emotion and fast money chasing the reflation trade. There’s nothing wrong with being incorrect at certain points, but the real key to trading is to adjust quickly. Being wrong isn’t a flaw, but staying wrong is. Always remember if you follow me, I’m trading on a much shorter timeframe than almost everyone else you see on energy Twitter.

 

So where does energy go from here? I think the answer to that question really depends on what the overall market does this week. The best case is that the TLT finds a bottom, the UUP fades again, the SPY/IWM bounce and then XLE follows. If the IWM can regain 226.50 and make a run at 230, then I think XLE can make a run at 54. The unknown variable for me is how much supply is in that 54 area and how eager are sellers to exit their positions? It’s really the same question/issue that the sector had at the 46-48 level, how much supply is there and can the buyers chew through it? If the overall market starts to look shaky, does that supply get aggressive and start to move down on the chart, specifically moving just inside the latest high around 51? Just consider if you were a longer term holder in XLE, say somewhere from 2016 to 2019. You rode out the crash for some reason and price is now bouncing back and getting you back close to breakeven. You are watching the overall market and you feel like it’s topping on the longer term. What do you do? For the ones that really want out, they are going to drop their selling price and try to get inside the latest price range (51). On the other hand, if the market starts to rip (maybe a blowoff top?) what would you do? You would probably stand firm in the 54 area and wait for price to come to you. The same logic applies to the group of buyers below 40 that wish to take profits, as well as the group of bears patiently waiting to short the sector at this 10 year supply point. This is why I say this week’s action in XLE probably depends much on the SPY.

 

On Thursday, I posted a ten year chart of XLE going all the way back to 2011. There’s a huge supply level at 54. If you pull back to a 30,000 foot view weekly chart, it looks roughly like a huge head and shoulders pattern with 54 being the neckline. There are probably still a lot of holders in XLE who entered above that neckline. Will they pick that neckline spot to attempt an exit? The key, as I always say, is the math. Buying into a level where there is likely a lot of supply is usually a long term losing bet. I’m not saying that price can’t cut through 54, because it most certainly could. What I’m saying is that the odds just don’t say that’s a positive expectation play over the long run.

 

The better move if you want to establish an XLE long position now is to wait for a pullback. Entering here around 48-50 gives you at most 6 points of profit if price stalls at that 54 level. The downside could be 8+. Not good odds. The odds of the trade being successful increase significantly with a pullback to the 42-43 area. An entry there produces 11 points of profit at the 54 level, more if it breaks through. The risk on a 42-43 entry is maybe 5 points. You have moved from a trade offering you 6 reward/ 8 risk to a trade offering 11 reward / 5 risk. The odds needed to break even on the former trade are 57%, while in the second trade you only need to be right about 31% if the time to break even. It’s simple math. Quite a difference for just a little patience.

 

As for the technicals in the XLE this week, I’m watching the 46.25-46.50 area on the downside. That level held three times. If price breaks below last week’s range and establishes there for any decent amount of time, then the pullback could go to that 44.75 point where price jumped on the open back on Monday, February 16. Any drop below 44.75 risks taking a shot at that October 30 VWAP in the 40-41 range, at which point I’d definitely be looking at a long play. On the upside, the first level to watch is last week’s VWAP at 48.75. That price will likely control the action on Monday. If price breaks above it, there’s a fairly easy run back to last week’s highs around 50.50. Any move above that would likely require the IWM and SPY to be moving up sharply, so watch those for further guidance. Again, if the highs break, the level to watch becomes 54-55.

 

Trading Plan for the Week – My primary watch is the GDX play. I’ll be watching the UUP for the speed of any upward trend and where that trend might stop. If the dollar moves sharply, I’ll be very patient with building the GDX long. I’ve already got a small position from 31.50. I posted on Twitter the longer term plan on the GDX play and the weekly charts that support it. I think the entry on the play is in the 30 area, but if the dollar really does jump, I could see the GDX getting to the 27-28 area on a selling climax. It’s going to be a difficult entry, but I like the reward on the trade since the FED can’t stay out of the market. I’m looking for the GDX to make a run back to the upper 30’s, possibly as high as 40, especially if the larger market has some type of major setback and money rushes to the safety of bonds and gold. Also, there’s a really good chance that I don’t take this trade at all. If I see more signs that tell me the reflation trade is failing quickly, then I might just let this one go. I’ll post the entries on Twitter as I make them.

 

My next trade watch is a long in IWM. If the market does make that blowoff top, I want to be long something for the ride. I’m watching the 215 area on Monday to start in on a long IWM play to ride that move. If things look bad on Monday or there’s a big gap down, I’ll probably just step aside and watch for further clues. The ultimate plan though is still a short play in IWM after any blowoff move. It would definitely be nice to ride the move up and then flip to the short side, as that would provide quite a big margin of error and allow me to size the short up fairly large.

 

The last trade on the radar is an XLE long if we get a pullback. There’s an OPEC meeting coming up soon and that could be a catalyst that sends XLE down, although likely only temporarily. I’ll start to get interested around that 44.75 area and would definitely build a big position if price got back in the 40-42 range. I don’t think it will drop enough to start a long play this week, but that’s what I’m watching.

 

I’m still doing some daytrading, but I rarely post those to Twitter. It just seems to junk up my timeline and mostly confuses people when I trade in the opposite direction of my larger plays. So I’ve found it better to just omit it. I’m always open to questions about it though if anyone wants thoughts on intraday plays or market direction/levels.

 

That’s all I’m watching this week. Still no individual names right now, mostly just trying to really focus on the macro picture and these larger trends for some medium term swing type trades. Once the market shows a true turn down or clear upward resumption with plenty of room to run, I’ll then move back to individual name plays. Be careful out there and remember, this market can turn on a dime and the quicksand can trap you.  Good luck this week.

Weekly Energy Equities Review, Market Outlook and Trading Plan for 22-26

This is a difficult market. I went back to 100% cash on Thursday and have no real desire to jump back into anything this week at these levels. I had a great short position in IWM from around 227.75, and I really thought it might pull back toward the 215 level, possibly even 205, but it ran into a wall of demand Thursday around 220 causing me to cover, which was good because it ripped right back to 225 Friday. I posted an interesting chart on Friday showing that there may indeed be another leg up coming in IWM, possibly to the 245-250 area. I doubt I’ll be riding that long, but I have no problem sitting back and waiting for the short play if this is a blowoff top.

 

The only thing I can really say about this market is that correct risk-controlled trading gets more and more difficult as the market disconnects from reality and the bubble grows. Sometimes you just have to exit the game for awhile and just watch the action because the odds on one side just don’t offer anything with a long term positive expectation. Trading on the long side is getting VERY expensive. It’s a bit frustrating to slow down when the masses are pedal to the metal long and making money, but I’ve also been doing this long enough to know those guys will stay at the party too long and lose everything, and then some. I know, because I’ve done it before. We think of a market disconnecting from reality, but the truth is the market is nothing more than individual traders, you and me. The market is not some external entity, it is made of us, and many are trading on the edge of disaster in a market that they think will never go down. The “market” isn’t disconnecting from reality, we are. It’s time to tighten things up. Size down, tighten stops, be more selective in your setups and realize that things can change on a dime. Survival above all else.

 

SPY – It was a bit of a negative week for SPY. It opened at new all time highs around 394 on Tuesday morning, but then just drifted down all week closing at 390. The week’s VWAP was 391.15. It really didn’t give any clues for what to expect this week, but the important points to watch are 393-394 area on the upside and 387-388 on the downside. Given what this market has done for the last three months, you have to assume that the bull keeps running. I won’t be getting long, but it’s also a very difficult place to get short. I need to see some real euphoria and another price spike before I attempt another short play.

 

QQQ – Tech was much the same story as the SPY, but the QQQ remains in an uptrend. I’m watching the 338-339 level on the upside and the 326-328 level on the downside. The interesting watch in tech is AAPL. It’s getting dangerously close to breaking its uptrend, so keep an eye on 127. A breakdown in AAPL would probably put in a top for MSFT and then trickle into the other FAANGs, especially FB, GOOGL and AMZN, all of which have been consolidating for months trying to decide which direction to go. If AAPL and MSFT turn down, then FB, GOOGL and AMZN could decide to break to the downside out of their consolidations, at which point the lesser techs could follow. As rates climb, keep an eye on tech.

 

IWM – Small caps are still my favorite short target and last week showed the potential for profit on the short side. IWM opened the week around 230 and gave up 10 points in three days. You have to be nimble to catch the moves, but the big move is coming soon and that’s the wave I’m looking to ride. I think there’s probably another move up coming in IWM, especially if the action I described above evolves in the QQQ, and if rates keep rising. There has been a rotation from big tech to small caps going on for months and that could accelerate if tech makes a move down. The rotation has been primarily from tech into banks and energy, so keep an eye on that QQQ/IWM correlation for clues on energy, as well as the TLT/XLF for clues of money rotating into banks. If IWM and KRE keep going up, that’s a good signal that XOP/XLE will follow.

 

TLT – Bonds are trapped in a brutal selloff, which is causing rates to rise faster than the FED wants. The real issue for equity traders is where do rates top out, or alternatively where does TLT find a bottom? At some point, rates will reach a point that spooks the equity market.  On the other hand, there’s probably a point where rising rates will cause the FED to step in and blow even more air into the bubble. I don’t know where either of those points are, but if we start having more days where bonds and stocks are both red, that’s a signal you must pay attention to. I have way more experience with stocks than I do with bonds, but if I had to guess, the TLT should bottom in the next couple weeks. The low point on the pandemic panic back in March was around 138, while the TLT closed around 143 on Friday. I’d say 136-138 would be a good spot to possibly setup a long play for a bounce.

 

GLD/GDXTLT is also offering a big clue for gold. I posted a GDX trade last week, but I’m starting to get a little concerned about that setup. Both GLD and TLT have been moving together since August. For GDX, I am watching the 30-31 level, which was the breakout point from the Aug 2019-Feb 2020 base. The problem is that the TLT also made that same base formation, however TLT has broken below that level, will GDX follow and also break below that level? There’s a big level for GLD coming up this week. If TLT continues to fall, it will be difficult for GLD to hold the 165-166 level. If that level breaks in GLD, there’s easily 10 points of room to 156-158. That should be enough to knock GDX down to a possible entry location. The only worry I have with this trade is that the GDX gets into a spiral down toward the 25 level. Definitely have to be patient with the entry and scale it rather than plunging in with one move. I’ll post the entry on the GDX trade on Twitter if it arrives.

 

UUP/CAD – The dollar is still the big question mark in the macro picture. I wrote last week that there’s a level at 24.27 that the bulls must defend. It dropped to 24.33 and closed at 24.36 on Friday, so I’m thinking that demand level gets tested early this week. If that level holds and the dollar finally does turn upward, that’s going to knock gold down for a great entry into GDX. The only question is how fast is the rise in the dollar? I mentioned a downward spiral in GDX being possible, and that’s just what could happen if the dollar rises faster than traders expect. On the other hand, if 24.27 breaks this week and the dollar collapses, GLD and GDX should move back to the upside and that trade is probably gone. As for the CAD, it took out an important level Friday. It just keeps strengthening, which is a good thing for oil. Watch the 1.2600 level and then the 1.2700 level for clues on the dollar/oil correlation. If the CAD takes out 1.2600 and strengthens quickly, oil could keep moving up.

 

Most traders have just written the dollar off and they expect it to continue to collapse, but I think that’s wrong. As commodities rise, rates will continue to rise. If rates continue to rise, yields in the US currency will become more attractive in the Forex market and money will eventually flow into the dollar to take advantage of those higher yields. I think the dollar is getting stretched to the downside and the snapback could be quick, which could be damaging to commodity stocks including GDX and XLE. Watch the dollar this week, and if it looks like a bounce, then it could be a good move to lighten up on some of the commodity stocks.

 

XLF – As the TLT keeps dropping, financials keep rising. The XLF is now well above the 31.55-31.62 breakout area and it doesn’t look like there’s going to be an immediate re-test of that breakout area. Financials are in a blue sky area now and who knows how far the market will take them. I think there’s a really good chance that the XLF chart could end up looking very much like the current IWM chart. If you are long energy, then this XLF action is very positive since both sectors have been running together on the rotation out of tech into banks/energy. Watch the TLT/XLF correlation for clues on the energy sector.

 

Energy XLE/XOP – The XLE is trapped in the 45-46 area right now, which isn’t a bad thing. Price stayed in a one dollar range for the entire week, which is a little unusual for energy. There’s a huge supply level in that area which extends back to the March OPEC meeting disaster at 46 and the mid-June highs around 47. The buyers are chewing into that supply. The real question is how much supply is actually there? Do we run out of buyers before all the supply is cleared, therefore leading to a big pullback? Or do the buyers actually chew up all the supply and break through that level and make a move at the next supply level up at 54? I’m really not sure how much supply is there, but I think it’s fairly large. If the overall market keeps rising, then the buyers will keep chipping away at that supply level. However, if the SPY finally gets a pullback, the demand for XLE might step back and the remaining supply could get aggressive and start moving down on the chart, thereby producing pullback toward the 40-41 area.

 

I’m still bearish on energy. I think people who read my Twitter or blog think I absolutely hate energy, but that’s not true, I just don’t like the current trading position of energy. It’s just in an area where a long trade just isn’t worth the risk, and it’s been in that area since early December. If it moves to a better area, then my bias changes. The max return on the trade is still that 54 area (8 points), while the downside could easily be 37-38 (8+ points). The odds on either side are probably 50/50, so the trade just doesn’t have much expectation to offer right now. The better move is to let XLE pull back toward the 41 level and then take the long trade. In that situation there’s 13-14 points of potential profit with about 5 points of risk, while the odds of the trade working are still around that same 50/50. The long trade at 46 offers no long term positive expectation, however the long at 40 is nearly 3:1 and a huge positive expectation. If it did pull back that far, I’d likely move to being a bit more bullish and might even take a shot long in that area. Most times trading isn’t about being right or wrong, it’s more about what you win when right versus what you lose when wrong. While I am bearish on XLE right now, that doesn’t necessarily mean I hate energy, it simply means that the I don’t like the long side of energy given these odds and payouts.

 

As for the technicals for energy, I posted an XLE chart last week showing an upsloping channel which started back in the first week of December. Price has moved just above the upper channel and also right into that thick supply area of 46-48 which goes back almost a year. XLE is right in a very likely pullback spot right now, yet it hasn’t dropped at all. There’s demand at this level, but again, there’s also huge supply blocking the way up. I’m watching 48 on the upside for clues this week. If it can break through this wall at 46-48, there’s no reason that it can’t make a quick rip toward the low 50’s, at which point I’ll probably move to the short side. If price rejects in this 46-48 area, then the supply probably starts getting more aggressive and 40 becomes the downside point of information. If price reaches the 38-40 area I’ll probably move to the long side. Again, my bias isn’t so much on the energy sector and its fundamentals, it’s much more based on trade locations, odds of success and risk/reward offered.

 

For Monday in XLE, it’s all about the top of last week’s range around 46.50 and the bottom of the range around 45.50. Last week’s VWAP was almost perfect center at 45.95. One thing I would point out though, if you are a breakout trader, be really careful here. This thing is setup to where it’s going to give you a false signal on the first break. If it gaps up or breaks to the upside Monday, I’d be really cautious chasing that. Same story on any downside gap or break, it’s likely a stop hunt for a run to the upside. If I see the downside stop hunt, I very well might put on an intraday long trade in XLE. If you are trading XOP, the basic theme is the same, but just a little more tricky. There’s a heavy fair value area around 77.25, with the downside being 75.50 and the upside being 79. The XLE setup is a much easier trade, however the XOP trade probably offers more reward to the upside.

 

Trading Plan for the Week – On Monday I’m considering an intraday long trade in XLE. I’ll be watching for any gap down or breakdown early in XLE. If I see it and think it’s a stop hunt, I’ll put on a reclaim trade as price re-enters last week’s (or Friday’s) low, with the stop being placed a safe level below the Monday morning low point. On this trade setup, you MUST let price get sufficiently back within last week’s price range or there’s no trade. Don’t anticipate or guess or try to front run the trade, just let it develop and then enter. That’s really the only daytrade I have on the radar for Monday.

 

On a bit of a longer term (for me anyway) I’m watching a possible GDX long trade as price breaks under 32. I’ll be looking to scale into the trade in probably four pieces. This one will require some patience, as the GDX could spiral down quickly if the dollar and TLT move sharply. The key is to wait a long as possible for the first piece entry. Once in, I’m looking for the trade to move back up toward 36-38 for a 20% gainer. I expect there is some FED action coming if rates continue to climb, which could help gold.

 

On the same timeframe as GDX, I’m also watching XLE for a long play in the 40-41 area. This is another trade that could spike down quickly, so scale entering in a few pieces is probably the way to go. A scale started at 40 could probably go with four pieces down to 35. The reward on that trade could be >25% if the XLE does eventually take a shot at that 54 level. Worst case is an entry around 40 with another (fourth) shot at the 46-48 level, for a 15-20% gainer. I really can’t see energy going much lower than 35, unless the overall market gets really ugly, in which case I’d be cautious to enter anyway.

 

I’m watching the move up in IWM for another short play. I think the euphoria in this market is most evident in small caps. I’ll be watching 230 this week for clues. I might try a smallish short trade at 230 depending on the speed of upward movement, but what I’d really like to see is a breakout of 230 and a very quick move to 240-245 for a really big short position. The IWM short will require some patience and it’s definitely a trade where the entry is a scale in with probably four pieces.

 

I’ve got TLT on the radar for a possible long play this week, but I’m not sure where that trade location is. Bonds are extended and eventually the FED is going to step in. I’ll be watching this week for any tradable setup to the long side, especially on any selling climax early in the week.

 

KRE is also on the radar for a short play, but with the TLT/XLF correlation, I’d probably be better off playing the TLT long rather than trying to play the KRE short. Even if bonds find a bottom, financials could continue upward. However, the KRE is running into some supply at the 65 level and given the speed of this move up, there could be a pullback coming there. A short on a rejection of 65-66 could be a play this week.

 

Those five trades are really all I’ve got on the watchlist for this week. I’m still avoiding individual stocks right now, as all of my possible plays are larger market, macro type plays. It’s really frustrating to be right on the macro picture and then play an individual stock that simply ignores the larger picture and does something totally unexpected. There’s a good chance this market continues to grind up this week, but like I said, the long side is becoming really expensive. It’s kind of like betting on the heavily favored home team in sports, at some point the odds just get too high and don’t represent the skill of the team, it’s all geared to take advantage of the home team fan/bettors. And that’s when the upset is just around the corner and the correct play is to go against the home team. Good luck this week.

 

 

 

 

Weekly Energy Equities Review, Market Outlook and Trading Plan for February 16-19

Twitter is a great place for exchanging market opinions. You can find almost any opinion on there to support any trade or market view. But one thing I’ve noticed lately is not so much differing bull or bear opinions, but simply the fact that energy seems to be drawing a greater number of opinions, and the opinions are starting to be more assertive and emotional. Much the same thing happened in March during the OPEC fiasco. Last March you couldn’t find a single bull anywhere, now you can’t find a bear anywhere. Significant? Does this increase in hype and emotion mean we are reaching a turning point and a possible market pullback? Maybe.

 

One thing that is a bit strange on this latest energy run, and the entire market for that matter, is that nobody has really given any reason for it, yet I can give a list of reasons why it’s probably shouldn’t be running. The biggest and most common bull reasoning floating around Twitter is some form of, “the economy is going to be lit AF as soon as this virus is over bro, party on oil!”. It’s almost as if everyone is looking for this mystical promised land somewhere in the future, yet the view has absolutely no grounding in reality. That kind of situation was exactly like the internet bubble where all the problems of the present were simply pushed aside for the utopian future that the internet was going to bring.  Is oil running on its own merits or is it simply a broken down boat being lifted by the tide of the overall market and looking for some mystical shore?

 

I feel like I’m the only energy bear in the world right now. I haven’t found the right trade yet and I have no short position yet, but I think the opportunity is coming soon. This market is getting close to a blowoff, both overall and for energy specifically. I’m not sure exactly when it’s going to happen, but I’d guess within the next 6-8 weeks. Here’s a few reasons why I think this energy move is about to exhaust itself:

 

The first angle I think people are missing with oil is the political angle. Can Biden stand the pressure of $60+ oil? At what point do rising gas prices start to take a toll on a very weak and recovering economy? Many times high oil prices are itself the thing that kills the sector run. If this virus situation does magically go away, how far up are gasoline prices going to spike when travel opens up? These are the questions that the government and FED will have to deal with. Do we end up in a situation where the rise in oil prices is the cause of its own death? Biden does have some options for higher oil prices. Remember about a year ago when Trump filled the SPR with sub $30 oil? Think Biden won’t use higher oil prices as an excuse to release all that Trump oil at double the price and claim the profits as his own? Or does Biden use $60+ oil as an excuse to justify even larger regulation of fossil fuels and justify new green technologies which will hurt oil in the long run even more? There are many other political pitfalls out there and oil prices might be getting close to that danger zone where politics will become an issue for the bulls to worry about.

 

Next is OPEC. At some point soon, they will want to cash in on their work. They have done everything they can to get prices up and now it might be time to turn the taps back on and collect the benefits of that higher price. I think they have reached the end of their cuts and that might be a shock to the market at the next OPEC meeting. Russia is probably going to be the cause of those cuts ending or even reversing. Things aren’t going well for Putin right now and elevated gas prices aren’t going to help him. He agreed to cuts that he didn’t want a year ago, now he’s going to be expecting Saudi to return the favor by ending those cuts. I feel like the market assumes these cuts are going to last forever and that this is the new normal, well, it almost assuredly isn’t. Remember how the stock market responded to the FED’s taper? You could very well see the same response in oil to an OPEC taper.

 

OPEC also finds itself right back in the situation that started this price war. Prices are rising and US shale is putting rigs back to work and increasing production. You think Saudi is going to keep the cuts in place while the US jacks up production and takes advantage of the high prices that OPEC created? Not likely. There’s a good chance we have reached the end of this cooperation cycle. When things got tough everyone banded together to save oil prices, but now that price has recovered it’s back to normal competitive behavior. Can US shale compete?

 

SPR and OPEC issues are really just supply side elements. As I wrote last week, EIA numbers haven’t budged during this latest oil price run. Inventories sit right where they were back in October, with gasoline and distillates being even higher. That’s very similar to where things are all around the world on the supply side. There’s still a huge amount of supply out there and it’s just waiting to be tapped. I keep seeing all these claims of low supply, but the numbers just don’t confirm it. There’s also another side to this problem – DEMAND. Just as the weekly EIA numbers haven’t shown much change in inventories, they also haven’t shown much change in products supplied. Current demand just isn’t there yet.

 

If oil is going to justify this latest run, demand is going to have to pick up, and soon. The market seems to have this fantasy that oil demand is going to climb back above pre-pandemic levels, but I think people are very wrong on that prediction. The psychology of the public is damaged. It’s not a switch that can be flipped on and off, it’s going to take YEARS to change the attitudes of citizens. Just look at the mask issue. People can’t live without them now. You think when things get a little better that everyone is just going to take their mask off on the same day and throw them all in the trash? No. It’s going to be even worse with travel fears. That fear is real and it’s not going away anytime soon. Do you think corporations are all just going to bring every employee back to an office? No. Work from home is going to be huge from here on out. How in the world can you expect oil usage to get back above pre-pandemic levels when we don’t live in that kind of world anymore? Things have changed and oil demand will feel that change for years to come.

 

Also, the above assumes that the virus does go away. I’m of the camp that it’s here to stay for years. It can be managed, but it’s never going away. The government will continue to make more and more rules regarding travel. Instant tests, masks, quarantines, etc. Many people won’t travel just because of the hassle. Just look at what we do now, we are still taking our shoes off at the airport over ONE event that happened 20 years ago. The same will happen because of the virus.

 

We also have green technologies to deal with now. Look at all the electric vehicle companies coming online. You think that is going to help future oil and gasoline demand? Oil is a dying industry. It’s not going to be a sudden heart attack, more like a chronic disease that takes years to finally become fatal. But that death is coming. Most of us here are short term traders and we don’t move the market. If the energy sector is going to move to significantly higher levels, that’s going to require huge buyers with very long term outlooks.  Does the long term exist for oil anymore? Or has the oil sector turned into a “trading” sector where the money cycles in and out without any sustained gains or future? Look, I love the oil sector, but you have to be honest with yourself and realize oil is probably closer to its end than its beginning.

 

The above are just some of the things that I think will cause the sector to top out soon. If you notice, almost all the things listed above have nothing to do with the actual companies themselves. The energy sector is being pulled along by forces other than company fundamentals. If you really want a depressing look at energy, just take a look inside most of these companies. The huge debt is still there. The dividends are a massive albatross that is killing their budgets and cashflow. Management still contains the same idiots who were running the show a few years ago, taking huge bonuses and living with a drill until we die attitude. Many companies have used a majority of their prime acreage and are now down to second tier land. Take a look at the Baker Hughes rig count, it’s up big over the last six months, yet production hasn’t moved up, why? Maybe it’s just a delayed reaction, but what happens to oil price when all these rigs do start pushing production way above the current 11 million per day? Or are we down to second tier land that isn’t producing as much oil with the same number of rigs?

 

Sorry to throw all that negative stuff out there. I could probably throw another couple pages of negatives out there, but it all just points to the same conclusion. My point is to show that there are MANY negatives out there for oil, yet all I see everyone talking about is “how awesome everything is going to be when Covid goes away”. Traders are focusing on a dream of what MAY happen rather than focusing on the fundamentals and things that we know for sure. That’s how bubbles are, they lose touch with reality. It’s a recipe for disaster and that’s why I’m bearish right now. At some point soon, the true underlying facts will matter and the dream will die a quick death. That’s the point where I want to get short. If I miss some upside, that’s fine.

 

Enough with the depressing oil views. As for the rest of the market, I think there’s a couple more weeks of euphoria left in this run that started back in November. The Covid move started back on February 24, 2020 and we are approaching the one year anniversary. That might be as good of an excuse as any for a pullback.

 

SPY – The SPY was fairly flat for the week. It opened 389.30 and closed 392.64, and that’s with a $2 tape paint on the close Friday. Basically, the index did nothing last week. Momentum has stopped and some indecision has replaced it. The real question this week is whether this is just a pause to refresh and then a move up or if this is true indecision which could lead to a pullback. I think we will know by lunchtime Tuesday. If this thing gaps up and then takes out the 387-388 level, then it’s time for a pullback.

 

QQQ – Tech had a fairly flat week. It opened around 333 and was trading 335 before that final 30 minute pump on Friday. Same as with SPY, is this just a pause in the trend or is it indecision leading to a pullback? Watch 335 and 330 for clues.

 

IWM – Small caps are my short target right now. I’ve got about 40% of the position I want with an average price on the short of 227.75. I’d love to see one more blowoff move this week to get the rest of the money in. If I could get the average price on this trade up to the 232 area, I’d be very happy with the trade. One thing I noticed about the IWM this week was that when supply did hit, there were no buyers there. It’s almost as if traders are distributing this right now on the way up. The market only rises when there’s no volume. That’s a sign that someone wants to keep the price up to allow distribution at the highest price possible. I’d be much more bullish if the moves up were on good volume, but they aren’t. If a few big sellers do show up, I don’t think IWM has any chance of staying up against them. The only question is WHEN are they going to show up.

 

XLF/KRE – I think this sector holds the key to the overall market direction over the next couple weeks. I’ve posted the TLT/XLF correlation chart a few times and it’s holding true. As TLT moves down (rates up) the banks move up. It makes sense because the banks make more interest income with higher rates. I’m a little concerned about the relationship though. Last week bonds fell to new lows, yet the banks just couldn’t show any meaningful breakout. I can’t really count that final hour on Friday, which was a pretty suspicious tape paint on a boring Friday before a three day weekend. If banks fail again at last week’s highs, that’s the first red flag that the overall market might be getting ready to pull back.

 

GLD/GDX – I’ve been waiting on GDX to get down to the 31 level for a long trade, but I’m starting to think it’s never going to happen. It’s looking like GLD and GDX are both at a decision point right now. They have both been in a downtrend since last August and a change in that trend could happen soon. Also, there has been a direct correlation between GLD and TLT, so keep an eye on the TLT downtrend. If TLT starts up, I’d expect GLD and GDX to do the same. There could be a good trade there if you can time it right.

 

UUP/CAD – This might be the most important watch of the week, especially for energy. The UUP made an effort at turning upward and trying to break its long downtrend, but it has dipped over the last couple of weeks and now sits close to an important demand level around 24.30. I’m looking for the UUP to drop down and test this demand and if it holds, we could be getting close to a change in the larger dollar trend. The weak dollar is driving the entire macro picture right now, especially commodities, including oil. The USD/CAD is showing the same structure. There’s a level in the 1.2600-1.2650 area that needs to hold if the dollar has any chance at reversing. This relationship was very evident Friday. In pre-market trading, the USD/CAD made a big move up, USO was negative and XLE was down about 1%. But when the market opened the dollar collapsed, oil ripped up and took XLE with it. The correlations between these are getting stronger, so keep an eye on them. Also, if the UUP does make a big move up, watch GDX to possibly come down near 31 for an entry. It feels like everyone just assumes this dollar weakness is going to continue forever, but I think it may change sooner, and more sharply, than people are expecting, which is even greater reason for my cautiousness on energy at these elevated levels.

 

Energy XLE/XOP – I mentioned this in a Tweet yesterday, but if you go back to the early November run, the XLE went from about 27-28 first week of  November all the way up to about 42 on December 10. We now sit at 45. If you weren’t in for the month of November, you missed the move. The XLE has done almost nothing for the last two months. This is one of the reasons that I just don’t understand the “energy is a huge outperformer” crowd. Yeah, it had a good move for a month, as did the entire market, but what has it done since? ALL sectors are moving up and many have moved up even greater than energy since December 10.  Technically, it’s sitting in an uptrend channel, but right at the upper channel level. It’s also sitting at a huge supply level around 46 from the March 9 OPEC disaster, as well as the June highs of 47. The XLE needs to break that level soon or it’s going to get tired and need a pullback. I don’t know how much supply is in this 46-48 level, but the chart suggests that it’s a huge amount, but you never know for sure.

 

If the XLE does somehow break through this 46-48 level, there’s an even bigger supply level sitting around 54. That point basically marks the pandemic start level, as well as the lower range of an XLE specific range that started way back in 2018. Not a small level and there could be massive supply there that could be a cap on the sector for a long time. If I was planning a longer term XLE trade from the long side, the 54 level would be the highest potential reward number for the trade. That’s probably your max reward in the shorter term for risk management and position sizing calculations.

 

I also keep seeing people say that energy is setup for a short squeeze. I just don’t see it. Who would possibly still be short after that fall in March? Everyone who was short covered there for a very profitable trade. And the ones who didn’t cover on the March crash most definitely got squeezed out on the November run. There is no significant amount of shorts left in energy, that trade completed. There may, however, be a whole group of shorts on the sideline (including me) who are looking to get back into the short trade that was so successful over the last few years. Those sideline shorts are a part of the supply which resides at the 46-48 and 54 levels. Another huge portion of the supply at those two levels are desperate traders who have held throughout this entire Covid drop. I’d guess there’s a huge group who would be thankful to see this thing top 46-48 so they could dump and get out somewhere close to breakeven. So, you have new shorts looking to sell to enter, old longs looking to sell to get out breakeven, and a crowd of profit takers ready to sell and cash in their tickets that they bought in October-November. That’s a whole lot of sellers just overhead. Is the possibility of maybe making 6-8 points worth buying into all that possible supply and risking 7-9 points downside? I don’t think it is. The smart play is to wait for a pullback. I posted that chart on Twitter Saturday.

 

As I posted on Twitter, the XLE is just in a spot where the math says a long here around 45 just isn’t justified by the potential reward versus the potential risk. I’d say the odds of getting past the two overhead levels on a single push are very low, definitely lower than 50%. Here at 45 you are risking 7-9 points to make 6-8 points, that’s LESS than 1:1 or even money. At best, the trade is a long term breakeven play, at worst it’s a HUGE negative expectation play. The correct move right now (if you are bullish) is to let this pullback to 40 or so. An entry there gives you the same 50% chance of the trade winning, however you get paid 10-11 points while only risking 5-6 points. That’s almost 2:1, rather than the 1:1 you get on the 45 entry. You only need to be right about 33% of the time when you take a coinflip 50% trade getting 2:1 payout. That’s much better than taking the 45 entry which requires being right greater than 50% of the time to show a profit.

 

The point of posting the math above is that sometimes the fundamentals don’t matter. Opinion doesn’t matter. Being right or wrong doesn’t matter. Sometimes trading just comes down to the mathematical payout odds versus the probability. Like any good gambler, and we are ALL gamblers, making money requires that we ALWAYS keep the math and odds in our favor. I see too many people taking expensive trades. Yes, you may hit that inside straight draw and win the current pot, but over the long term you will bleed your money out until you go broke. Always think about long expectancy in trading.

 

Trading Plan for the Week – I’ve got the short IWM trade at 227.75 and I’ll be looking to add to that position. I’ll be watching for a gap open Monday that fails and re-enters last week’s range. At that point, I might add 10% to my short trade and then add if it gets near the bottom of last week’s range. If the IWM gaps up and starts running, then I’ll probably start watching the 231 area to start scaling in the other 60% on the trade.

 

The second watch is XLE. As I’ve been posting, I’m watching the 46-48 level to get short. The XLE is showing some relative weakness to the XOP, mostly because of the excessive movement of the very small caps in the XOP, so I’m more willing to be short the weaker of the two. If you prefer the XOP, then watch the 78-80 area for a possible short entry. If you are bullish, then XOP is the way to go for the play. If the XOP can break this pre-pandemic level, there is space to 96 if things get crazy. But remember, along with that bigger reward comes greater risk. If the IWM does collapse like I’m expecting, the small caps in the XOP will catch the worst of it and the XOP could come down faster than XLE. When choosing between the XLE and XOP, it’s simply a matter of how much volatility you are comfortable with. For me, I like the lower volatility of the XLE as it enables me to more effectively control risk. Also, keep in mind that weather is pushing the sector more than normal right now. This cold snap has been brutal for an extended amount of time. While this is great for the present, it isn’t something you can extend very far into the future.

 

Also, I apologize for not covering the individual energy names over the last few weeks. I’ll try to get back to that next week. When I’m bearish, I’m usually playing the overall sector with the ETF. I have no desire to short individual names, that’s how you get blown out of the water in energy.

 

Hope you guys all enjoy the rest of this three day weekend. Keep an eye on your risk control and money management next week, things could get crazy volatile very quickly in the next few weeks. Good luck and feel free to hit me with any questions.

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

I’ve got a confession to make, I’ve been slacking on keeping up with my EIA stats. I looked at my notes and my last entry was October 16, 2020. Yeah, it happens. So I figured since USO has run up about 55% since November 2nd, that I should probably go back and fill in the information in my EIA journal to see exactly why the incredible price run in oil happened. I expected to find big drawdowns in oil, gasoline and distillates, import/export changes, higher refinery inputs and all the other stuff that would have alerted me that a big jump in oil prices was coming. But you know what I found? Absolutely NOTHING. Much like the rest of the market, oil prices have disconnected from the normal fundamentals.

 

My last EIA entry on October 16 recorded oil inventory at 488, gasoline at 227 and distillates at 161. Compare that to the last EIA report of January 29: oil 476 (only because of a 9.9 mil draw Jan 15), gasoline at 252 and distillates at 163. Oil was roughly the same without that one Jan draw, gasoline was HIGHER and distillates was HIGHER. Yet WTI ran from $34 to $57. What’s going on here? The only significant stat in the entire journal was an increase in refinery inputs from 13 million on October 16 to 14.7 million in the latest report. That’s about a 10% increase in oil to refineries, yet oil inventories are staying much the same with those refineries producing HIGHER and GROWING inventories of gasoline and distillates. Overall production numbers since October have remained constant at around 11 million. So why the 55% increase in oil prices?

 

One of my favorite places to look for clues is the refining sector. I watch the big three of MPC, VLO and PSX. Since late October, MPC has run from 27 to 48, VLO from 36 to 63, and PSX from 43 to 76. Refineries are a simple concept. Oil is pumped in, turned into product which is then sold. The goal is to sell the produced product for more than what the input oil costs. Since October the input cost has risen from $34 to $57, about +55%. The prices for the produced products haven’t increased much at all and products supplied (measure of demand) have remained fairly constant. Yet the stock prices as a percentage have risen even MORE than the percentage increase in their input costs (oil). More questions. What’s going on here? More disconnect?

 

Yeah, I know, the first response I always get is, “the market always looks ahead”. Maybe. What exactly would have to happen in the economy to justify this 55% increase in oil prices? Perfection? Is the market really looking ahead here and basing this huge run in oil on expectations that things are going to get that much better? Or is there something else? I don’t get into earnings reports that deeply,  but I took a look at the latest from RDSA the other day and I was pretty surprised. They aren’t looking for perfection in the future at all. In fact, their report was a complete disaster without much hope. It’s pretty much the same story for the other majors. More disconnect. The only positive I can find for any of these guys is the golden dividends. If that’s what people are betting on, then we are in real trouble and these things are way overpriced. Also, with regard to the dividends, if rates do keep rising, these dividends look less and less attractive, so there’s that possible downside for the big oil dividend payors.

 

So I guess the real question remains, why are these stocks, and oil,  rising so fast on what looks like a fairly blah current and future picture? Why the disconnect from the fundamentals? I think when we look back a year from now it’s going to be crystal clear that we are currently in a huge bubble that nobody can see. It’s like the 300 pound guy eating a donut and saying ‘these things are going to make me fat’. No dude, you are already fat and it was the dozens and dozens of donuts over the last few years that got you there. It just happened so slowly that you couldn’t see it. This bubble is like the frog boiled alive. The problem right now for traders is that they can’t see the forest for the trees. We are smack in the middle of the EVERYTHING bubble, yet nobody wants to acknowledge the obvious. Or maybe it’s just too obvious to acknowledge? Everything is in a disconnect right now, yet hope reigns supreme and everyone is in denial. This is one of the most difficult situations to trade and it takes incredible trust in your own skills and point of view to separate yourself from the herd. There’s absolutely no doubt, this is a bubble. The question is, how far do you think it’s going to go and can you time it well enough to profit from it?

 

Getting back to energy, I took a couple shots on the short side this week, but scratched them breakeven. I’m bearish. I feel like I’m the only bear left standing. But I truly believe that I’m right and this entire situation is a bubble. I traded through the internet bubble back in 1999-2000 and this market has many of the same qualities. The one similarity in both bubbles is that focus has shifted away from the present conditions (earnings and fundamentals) to instead focus on the utopia of the future. Attention has completely shifted from the problems of the current to how great the future is going to be. It’s a total belief by everyone that the future is going to be perfect. In 2000 everyone completely ignored the fact that most companies were making no money, but instead everyone focused on ‘how great the future of the internet was going to be’. Until it wasn’t. The same thing is staring us right in the face now. Everyone is ignoring the current problems and instead telling themselves how absolutely awesome the future will be when all this virus stuff goes away. Until it doesn’t or there’s other problems (like war, recession or any other black swan) to replace the virus.

 

The real problem right now in energy, as well as in small caps, electric vehicles and other green tech, is that the view of the future has replaced the reality of the present. The herd believes things MUST get better, but are you willing to bet your money that it will? I used to do a lot of sports betting in my younger days and there’s a method of betting called totals, or over/under as many refer to it. The market right now is very similar. The novices always bet on the over. They want scoring. They want things to happen. They want perfection and excitement. They want players to succeed and put up points so their over bet succeeds. They are optimists. The pros on the other hand never fall for it. They accept reality and bet the under. Novices wish for things to happen, pros accept that change probably won’t happen and that utopia isn’t a likely outcome, especially at an elevated price risk. And the pros are usually way more successful in their bets than the novices are. Are you betting that things are going to be perfect in the future, and paying premium odds for that bet? Or are you a pro and realistically accepting that things are what they are and taking the better odds under bet?

 

I know I got a little off topic there, but my point is to really make new traders question WHY this incredible run is happening, as well as making them question whether paying a premium to bet on perfection is really worth it. It’s no secret that I’m bearish for the next few weeks, so keep that in mind as I go through the macro picture below.

 

SPY – In last week’s run through the macro picture, it was clear that if the SPY based on that VWAP from late October it was going to take a shot at the highs. And it did. It was the same story for the QQQ and IWM. Last week’s run in the SPY felt a little different though. It was a straight up grind, which is very indicative of everyone being on the same side of the trade. Most Wall Street targets FOR THE YEAR are clustered around 400 and a melt up here could hit those targets. I keep seeing people predicting a big blowoff top is coming. But the real question to me is has it already happened? Was the run from November the meltup that everyone is predicting and they just don’t realize it? Are we all just frogs sitting in boiling water? The point to watch this week in the SPY is of course the high around 388.50, but more importantly watch the 381-382 area to see if there is enough demand there to support this latest rally. If 381 breaks, I wouldn’t be surprised to see the SPY give up all of last week’s gains, and more.

 

QQQ – Tech also made a new high, but there are warning signs and divergences everywhere in this sector. The biggest red flag to me is the divergence between the QQQ and SMH. Watch the 235-236 area in SMH on Monday. If it can break above that, then there’s another big supply area in the 238-240 area. If price fails again there, that could be a clue that tech is running out of steam. As for the rest of the FAANGs, AAPL and FB show similar divergences and AMZN can’t really decide what it wants to do. If the SPY does pull back this week, see if money runs to this “safe haven” of mega cap tech. Also, the inverse correlation between QQQ and IWM remains in play.

 

IWM – When this market finally acknowledges the ridiculous blowoff, this is the area that I’m targeting for a short. This thing is the biggest bubble in the entire market. There’s so much hope and euphoria that the small domestic businesses in the US are going to come out of this virus situation bigger and better than before, but I don’t buy it. I saw a graphic last week that the top 25% of the IWM businesses were trading at 100x earnings. That’s crazy expensive. These same small domestic businesses are also the most sensitive to interest rates, which are starting to move up. At some point, the market is going to get concerned about rising rates and the IWM could be the first domino that falls because of that fear. I’ve been doing my best to stay away from the sell button on IWM, but this might be the week that I put on a very big short play. I’d love to see a huge gap up Monday or at least a big run up Monday/Tuesday to start a short position Wednesday. Watch the 214-215 area to see if demand supports last week’s rally. Much like QQQ, if that point fails, IWM could give up all of last week’s run.

 

TLT – This is probably the most important watch for the upcoming week. As bonds sell off, that money flows to equities. The decline in TLT (rising rates) is getting mature and very stretched and might be near a reversal point. When it does reverse, I think financials and energy probably roll over. As of Friday’s close, financials (21%) and healthcare (20%) made up 41% of the IWM. If rates start to fall and financials drop, that’s going to hit the IWM hard and could be the catalyst for a reversal. If the TLT continues to drop this week, I’ll be more conservative on my short plays. I have no desire to fight this bonds/equities correlation.

 

GLD – Gold was interesting this week. GLD and TLT have been moving together since August, however they diverged sharply toward the end of last week. TLT had a severe move down, yet GLD managed a decent rally Thursday and Friday. See if that relationship gets back in sync this week. I think there’s a great trade setting up in GDX if it can drop down to the 31 area. It got near 33 last week and looked like it might collapse, but buyers stepped in. I’ll be getting long on any move down to 31.

 

UUP – I don’t think many traders appreciate the move that has occurred in the dollar over the last few weeks. It has turned upward and could be headed back up to that August-November range. If you compare the IWM and UUP charts you will see that the big run in IWM started at the same time as UUP broke down out of that Aug-Nov range. If the UUP can climb back into that range, that’s a clear warning that the IWM is overextended and due for a pullback. The UUP/GLD inverse correlation is functioning properly and if the dollar continues to strengthen, it could push GDX to the 31 level described above. Also, keep an eye on the TLT/UUP correlation this week. As rates rise, the dollar becomes more attractive for yield. If you compare the two charts, the turn upward in the dollar around January 1 corresponded exactly with the breakdown in the TLT. See if those two continue their inverse correlation, as it has great influence on banks, miners and E&P’s.

 

XLF/KRE – The direct correlation between banks and energy continues to be in effect. Banks (and energy) have also been the beneficiary of the rotation trade out of tech. As the TLT drops, rates rise and banks make more money. Watch rates this week to see if they keep supporting banks, specifically the KRE. If the KRE starts to weaken, then I’d expect the IWM and XOP to move similarly. Any divergence in the KRE/XOP/IWM correlation would be important.

 

Energy XLE/XOP – I’m concerned about energy right now. It feels like the run off the bottom is running out of steam, as the equities are diverging a bit from the actual commodity. As I described in the open to this week’s writeup, the fundamentals just don’t support the latest run in oil. Something else is causing the move up. I’m just not sure what that something else might be. One thing that is starting to concern me though is geopolitical tension, mostly Iran. That situation has the potential to get out of hand quickly if Biden isn’t careful. Other than that, I think it’s a simple reflation speculation trade, as well as the overall bubble frenzy, that is taking oil well past what the fundamentals would support.

 

If you go back to the March OPEC disaster, the XLE was trading around 46, about 10% higher than where it closed Friday. Looking at oil itself (WTI), it was trading around 47 during that OPEC meeting. It closed near 57 on Friday, or about 20% higher than where it was during the OPEC disaster. So we have the XLE closing 10% lower than where it was in March while oil trades 20% higher than where it was in March. One of these two things is very wrong. Are the equities too low or is WTI too high?

 

Given oil at 57, the equities should be trading higher, yet they aren’t. And this is with the market making new all time highs on a daily basis. Logic would say that given the spikes in oil and the overall market, that the energy sector should at least be higher than it was in March. Further, almost every other sector is above the February pandemic start, yet the energy sector isn’t anywhere close to the 54 level where it was when the pandemic started. It would take a 30% move up just to make it back to that pre-pandemic level. Something is wrong with this sector, it’s still sick. I think there are many reasons why it’s lagging, and will probably continue to lag. Just take a look at the latest earnings reports from the majors, especially that RDSA report. The future is bleak.

 

While the bounce off the bottom has been nice and many people have managed to scratch their way back to breakeven from that March disaster, I think many are falling into some faulty logic assuming that this sector should automatically be trading higher simply because oil and the overall market are trading higher. There is a negative divergence going on and you can’t just ignore it. Yes, maybe I’m wrong and there’s a huge move coming in energy to play catchup with the rest of the market. But honestly, given the very small size of the energy sector and all the money chasing things lately, if this move was going to happen it should have done so by now. I think WTI and the SPY are now extremely stretched while the XLE still lags. What happens when WTI and the SPY top out? If the overall market does have a 20% correction, I think the XLE could find itself right back at that 30 level very quickly.

 

So how do you play it? For me, I’m looking for the short play. I’m looking for WTI and IWM to top out and roll over.  That’s the entry signal for the short XLE/XOP trade. This isn’t really a prediction trade, it’s more of a math trade. Could the XLE rip straight up and catch up with the rest of the market? Sure. However, it doesn’t take much risk to find out if that’s going to happen. If I’m right on the short play, then I can probably find out whether I’m right with around $2 risk. And the reward could be $6-8, maybe more. On the other hand, playing the long side is difficult. At this level, it would take a stop of 38 to find out if I’m wrong on the long trade, which is about a $4 risk. There’s just not enough reward in the upside to justify that risk. I’m looking at maybe $6 reward on the long side. The long side is offering me 1.5 R while the short side offers 4 R. And this is with the odds probably 50/50 on which direction we go from here. Short is clearly the better trade.

 

If I’m wrong on the short idea and the XLE does break that 44 level, I can always flip sides and use that 44 breakout point as an entry/stop for a long trade for a possible run at 47-48. There are many different ways to trade the XLE right now, but given all the weaknesses in energy I’ve set out above, combined with the odds and payouts on the short idea, I think the clear choice for XLE is a short play.

 

As for the technicals in energy this week, the point to watch in XLE is 41. If this rally is to continue, there has to be demand at last week’s VWAP. If 41 holds, then the XLE probably takes a shot at the high around 43. If 41 fails, there’s a good chance that the XLE gives up all of last week’s gains and the pullback is on. On the other hand, if we open Monday and immediately take out 43, then the next confrontation with the bears comes in the 44-45 area, which tests the June and January high marks. A third failure there would not be good.

 

The same basic outlook applies to the XOP. However, the XOP has been a little stronger, mostly because the smaller cap holdings have been a favorite of the speculators. Weaker companies like CPE, CDEV and SM have similar weightings to XOM and CVX in the more equal weighted XOP, therefore those large moves in the small caps have overshadowed the larger caps and have led to a bigger move in XOP than in XLE.  That same logic will also apply when things turn downward. The point to watch in XOP is 68. If the rally is to continue, demand needs to show up at last week’s VWAP. On the upside, watch the 72 level for a possible breakout and test of the March OPEC price of 76. That would be my ideal spot to get short as there should still be a lot of traders holding from that point would would love to dump their holdings at breakeven. In addition, there’s a fairly large range extending from August 2019 to February 2020 which should also contain a lot of supply which should put a cap on the upside.

 

Sorry that kind of got long this week. The plan for the week is basically a short play in IWM with a scale in likely starting on Wednesday and a short in XLE and/or XOP when the IWM and WTI look like they are topping out. This market is getting dangerous, so tighten up the risk control and money management. Good luck this week.

Weekly Energy Review, Market Outlook and Trading Plan for February 1-5

Sorry for the lack of articles this month. Sometimes things move so fast in the market that all my trading is simply scalping and there isn’t much to write about. It’s probably going to be more of the same this week, but I thought I’d pop in and give some thoughts on the crazy action last week, as well as a quick look at the macro picture.

 

In my last post, I wrote that this market would likely give us a catalyst for the larger macro picture turn. The events of last week could very well be that catalyst. The media went absolutely nuts over the action in things like GME and AMC, which brought all eyes on the market. Everybody is looking to buy in now, and that’s probably the beginning of the end of this bull run. Things can go a little further as the frenzy reaches a climax, but the turn down is coming soon. Also, in my last post I wrote that shorting would emerge as a viable trading strategy this year and that’s looking like a good call. Almost all my trades last week were on the short side and it was one of my best weeks in a long time. There’s just so much dumb money out there and it’s creating pockets of mania where shorting is very profitable.

 

As for all the “traders” out there playing this insane speculation, all I can say is be careful. The Reddit/Robinhood crowd is gambling, they aren’t trading. Every trader in GME was just given that first hit of crack cocaine. For free. That’s what good dealers do. The market knows they will return again and again and again looking for that first hit high. And these Reddit traders will keep coming back, always looking for the next ‘short squeeze play’, yet they will lose each time until they give everything back and much, much more. The market just isn’t that easy. There was a mispricing or inefficiency and the crowd was lucky enough to find it. It’s a one time occurrence, not the basis of a trading career. The market will adjust and eliminate the short squeeze angle and then the gamblers will be left with nothing to play. But they will keep trying to repeat it and they will continue to lose until they give back everything.

 

While a few may have been very lucky in GME, it’s simply not trading, and it’s not repeatable. It’s a ONE TIME opportunity. The sad thing is that these gamblers will think what they have done is trading, not gambling. If I could give one piece of advice to all the people lucky enough to make some money in this market topping event it would be to take most of the money and put it in savings. If you really want to learn how to trade, then take 25% of your profits (after you’ve paid your taxes, of course) and really start studying. I can’t convey strongly enough that last week’s win was NOT trading, it was gambling. To be a trader, you need a standardized, and repeatable, plan. You also need money management rules. I guess my point is that anyone who won (or lost) last week really needs to realize that it was luck, not trading ability, that produced the gains. You can’t expect to make a career out of luck. Sorry for the rant, but this is something that I really wish I would have had someone tell me back in 2000. It would have saved me a lot of heartache, mental scars and damaged trading psychology that probably stunted my trading journey by several years.

 

Having said that, let’s take a look at the market and where things might go from here. The question on everyone’s mind now likely centers around where the top might be in this market. Do we make another run or was last week the catalyst for a turn and extended move down? My opinion is that there is so much cash still out there in the system that we probably get one more blowoff spike to the upside in the next couple weeks. After that, we’re probably headed down, and likely down a lot. Let’s go through each market one by one.

 

SPY – Last week was a fairly significant move down, going from ~386 to ~368. That’s about a 5% pullback, but the funny thing is that I don’t think anyone even noticed with all the other insanity going on. I’m looking for the SPY to test the 363-366 area, as there is a VWAP sitting there which is anchored from October 30. If that level doesn’t hold, then the market probably tests 353. If 363-366 holds early in the week, then there’s a good chance the SPY could take out the 386 high in the very near future. The volatility is increasing, which can often signal a larger turning point.

 

QQQ – Tech is probably headed for 300. The charts on all the FAANGs have topped out and could be rolling over. As you guys know, I’m not a big fan of canned chart formations, but the best descriptor that I can think of to convey what might be happening is a head and shoulders type formation. The market in many areas could have just put in (or is in the process of putting in) the ‘head’ on this theoretical pattern. This is especially true for energy, which I’ll cover. As for QQQ, there is a similar VWAP sitting around 303-306 which likely gets tested early this week. If it holds, then look for price to take out 330 on a blowoff spike. I think there’s more chance of seeing a spike in SPY or IWM though, so tech may lead things down and not be the best way to play a blowoff.

 

IWM – Small caps are the real worry in this market and my preferred short target. Last week’s action could have been a change of character move for this index. I’m looking for IWM to make a move down and test the 192-195 area soon. Ideally though, I’d really like to see this make one more move up to the 220-225 for a huge short play. The market speculation right now is in small caps and that’s where the blowoff could be the largest. IWM is one of my primary watches for next week for a short play on any blowoff move.

 

TLT – Rates are still in an uptrend, but things have stabilized over the last couple weeks in TLT. If the equity markets run into trouble, there’s a good chance TLT and GLD could turn upward and break out of the downward channels that started back in August. Keep an eye on the 155 level in TLT for clues.

 

GLD/GDX – The next retail target is supposedly going to happen in silver. I doubt it succeeds. The market has had too much time to get ahead of any possible short squeeze. I’d guess most positions were already stealthily covered, or hedged, last week in preparation for the obvious attack. There’s also a good chance that any attack on precious metals is going to run right into the teeth of a turn upward in the dollar, which would be a huge headwind. Any squeeze in silver or gold which occurred during a rising dollar would likely be met with larger holders dumping their positions to the speculators (bagholders). While I could be way wrong, I have no desire to chase any run in silver or gold, or the miners, right now. The only way I’d consider it would be if the dollar tumbled at the same time.

 

XLE/XOP – This is the area where the head and shoulders formation is the most obvious. There’s a clear left shoulder in XLE at 42 and head at 45. Price is quickly moving down to that 38 neckline. If it bounces, watch the price action at 42 for the formation of a right shoulder and subsequent move down. Also, just as SPY and QQQ have October 30 VWAPs near, so too does the XLE at 37-38. Watch the demand there for clues. The same pattern sets up in XOP with a left shoulder at 64 and head at 72. The neckline should be 58-59, with an October 30 VWAP also sitting right in that area. Watch the action at 59 this week. However, also watch the action at 64 early Monday morning. There could be a long trade there if demand shows up. I could see demand stepping in there if there’s one last blowoff spike in the sector. That last spike could take the XOP up near 78.

 

One last sector to keep an eye on is XRT. This was a trading goldmine last week. This thing has provided some of the best shorting opportunities that I’ve seen in the entire market in at least a year. I’m hoping there’s a Monday morning spike in the Reddit/RH crowd for one more run up in XRT for a HUGE short play. I’d like to see something near 100 to start scaling in on the short side, although I wouldn’t hesitate to put on some smaller trades in the 94-96 area. Give yourself enough wiggle room for some drawdown on your position sizing and be willing to sit for awhile to collect the reward.

 

Like I said earlier, sorry for the lack of articles, as well as the lack of Twitter posts. Given all the political idiots and now the Reddit/RH stock market ‘experts’, I just can’t do social media anymore. It has just turned into a cesspool of useless information, which is truly a shame because there’s a lot of guys I miss conversing with. I’ll be back once things settle down a bit, but for now focus on trading is more important. Good luck this week, keep an eye on the bigger picture and don’t get sucked in to the insanity.

 

 

Thoughts on the 2021 Trading Year

I think this is the year shorting finally returns to being a profitable strategy. Why? Mostly because everyone else is on the other side of the boat. Are there any bears left? Is anyone at all playing the short side anymore? Traders often focus on situations referred to as “crowded trades” and the normal logic is to avoid them, especially once they become very mature. This market is getting very mature and very extended. I think this is the year that logic finally applies to the overall market. I’m certainly not going all-in short, but short trades will certainly be more common in my 2021 trading. At some point, all this bubble inflated stock is going to have to be converted back to cash, and who’s left to buy this expensive overpriced stuff? The greater fool theory is getting near its cyclical end.

 

I’m not sure what the catalyst or signal will be when the market reaches that tipping point between bulls and bears, but there will be one. Sometimes it’s big, sometimes it’s barely noticed, but there’s always a catalyst. The real key to making money on the short side is timing. The account destroyer is being early on the short side. Let the catalyst happen. Let the reversal happen. Try not to outguess the market. When the market is ready to turn, there will be a signal, but it’s our job to stay alert and look for that signal. Don’t let greed cause you to miss it.

 

I guess my point here is not to get too confident. Stay focused on your risk control. I went through this in 1999-2000 and I’d love to have kept all the money I made in that bubble, but I hadn’t been trading long enough to understand how bubbles work and the need for keeping risk control. I got blinded by greed and thought that if everyone else was bullish that the party would never end. What was even worse was my arrogance in thinking that I would see the turn and get out before the bear took my profits. I didn’t. But it was a much needed lesson and probably the only reason that I’m still in the game. Be careful this year. Respect the lofty levels of this market and know that at some point the game will change. There will be a signal, so be attentive. Risk control is the top priority.

 

The first week of this new year is going to be an important one. I think we get a big run up for the first week or two of 2021, especially if there’s a favorable result in the Georgia Senate races. I closed out 2020 in 100% cash, but I’ll be putting some money in on the short side (probably IWM) if we get some type of buying climax as new money floods in to start the year. Many traders watch this “January Effect” situation, so be patient and let it play out, as it could be a good predictor of market direction for the next couple of months.

 

As for energy, I really didn’t focus too much on it through December. I spent most of my time focusing on the macro picture. I’ve really let my bigger picture view slide over the last six months and wanted to sharpen it again. I feel like I’m caught up there, so I’ll be posting more stuff that is energy related this year. It will be really interesting to see how energy stocks start off the first two weeks of 2021. It feels like there’s at least one more little push upward for them, but after that who knows where we go. I’m not bullish on energy at these levels and I think oil could top out soon. I’ll be trading them on the intraday level for the next month or so. I’m not really interested in trying to outguess the energy market with longer term trades.

 

My view on the real economy is probably more bearish than most. I really don’t think traders are focusing enough on the psychology of the public. It’s pretty depressing out there and most people have been trained better than a circus monkey with regard to this Covid stuff. I think most people have been psychologically damaged and I don’t think it’s going to be possible to simply flip a switch and undo that damage. Everywhere you go you see these masks. I don’t think we realize how much psychological damage these things are doing. It subconciously keeps the virus fear front and center every second of every day. There’s no escape from it. It’s even invaded TV commercials of all things. There’s no way in hell you are getting people to give up those masks even if things get better. I’d be willing to bet that 50% of the population will continue to wear them even when there’s no real threat left. People are going to continue to be fearful of going out for a long time. The market expects human psychology to change on a dime, but it just doesn’t work that way. The economic recovery is going to take MUCH longer than most people think.

 

There’s also plenty of things that can still go wrong with the Covid situation. New strains, problems with the vaccine, public perception and fear if people still die after getting the vaccine, etc. I think we’ve moved from a truly health centered problem to more of a psychology centered problem, especially for the economy. The fear is really excessive compared to the true underlying numbers. The media isn’t helping the situation, nor are the politicians. I’m really not sure if politicians even want this problem to go away, then what would they use as an excuse for all these funding bailouts and money printing? And this doesn’t even begin to consider the things we don’t know about yet. There’s still a whole world of problems that have been brewing while our eye has been off the ball and focused on the pandemic. And then there’s always the black swans we don’t know about. As I wrote a few weeks ago, this market is priced for perfection and there’s so much out there that could go wrong. Some call it a wall of worry, but this market has already climbed nauseously high up that wall, how much is left before it falls off?

 

Sorry for such a depressing view of the world, but that’s where my trading focus is at to start the year. I’m super cautious right now and I’m not willing to tie up money in longer term trades. I’ll be mostly daytrading over the first couple months of the year to avoid the increasing market risk. The only two longer term trades I’ll consider are a short trade on a buying climax in the first few weeks of 2021 or a long on a really big pullback in February/March. Other than that, I’ll be keeping it short term and mostly intraday. Good luck this year and keep that risk control tight!

 

Weekly Energy Sector Review, Market Outlook and Trading Plan for Final Two Weeks of 2020

Sorry for the lack of energy sector info on the Twitter feed the last couple weeks. I’ve been working more on my macro picture trading and just winding it down for Christmas. I’m probably done for the year in energy, but just wanted to make one final short post for 2020.

 

The only question I have about this market for the remainder of 2020 is where does this Election/Christmas rally stop? I’m still waiting for a spot to get short the IWM and I think I’m going to get that entry this week. This has been a crazy run that started around election time. If you would have told me back in October that Biden would win a contested election involving court battles, I still wouldn’t have been able to catch this 30% move in the IWM. I don’t follow politics closely, but I don’t think anyone expected this kind of move on a Biden win. But then again, maybe this move isn’t about the election results, but rather stimulus and vaccines.

 

I have to admit though that I’m pretty bearish right now. I’m not convinced that the vaccine is going to provide the public the safety it wants. There will be new strains of virus and vaccine side effects, and we haven’t even begun to see the media panic when vaccinated people start getting the virus. I think people have that 95% number stuck in their head, but when the true numbers come out, I think that number is going to be much closer to flu vaccine numbers in the 50% effectiveness range. When that happens, the media will once again begin their fearmongering and public confidence will take a few steps back, as will this market. I don’t think this virus problem is anywhere close to being over.

 

The market also expects more stimulus than I think the government is going to be willing to provide. How long can we keep throwing money at this problem before huge collateral damage begins to start showing? The consensus seems to be about 900 billion right now and then a second round of stimulus when the Democrats gain power. We may get that 900 billion round this week, but I think that’s already been priced in and could be a sell the news event. Another factor that isn’t getting enough attention is the Senate race in Georgia. If the Republicans win those, then there probably won’t be a second round of stimulus getting through a Republican controlled Congress. If the Democrats win those, then the Senate becomes locked at 50/50 and essentially disappears. With a locked Senate, all decisions are then made by Kamala Harris (tiebreaker), who would also have presiding powers over the Senate, as well as the tiebreaker vote. Let’s see how the market handles that situation in a year. I’m guessing it won’t handle it very well when things move from stimulus to tax increases and more frivolous legislation aimed at regulating corporations.

 

And what about the other black swans that are surely out there? Could we even handle another one? Could we afford it? Could the public survive even more stress and psychological pressure? I’m pretty sure that every troublemaker in the world is going to step up and test the new kid sometime soon after the inauguration. How will Biden respond? Would one of those troublemakers really step over the line into some kind of attack? If someone wanted to push America over the edge, now is the perfect time. Kick them while they are down. These things trouble me and I hope we never see them, but I think you have to account for their possibility in trading. And like they say, it isn’t even a black swan if you can predict it. What happens if there’s a swan that nobody could have ever predicted? I just think this market is priced to perfection right now and there’s just so much that could go wrong. I’m not willing to play these levels on the long side for the last couple weeks of thin holiday trading. Yes, I may miss a big run, but I’m also going to miss any big down move. Sometimes the market just isn’t in a great risk/reward position overall. I’ll wait for the new year.

 

Quick technical look around the market:

SPY – Watching 372.50 on the upside. If Stimulus gets passed this afternoon, then I think we gap up above that level. If things get delayed, then 362.50 is the spot to watch on the downside. Overall, I think the market probably ends the week within last week’s range between 364.50 and 372.50.

 

QQQ – Tech is still the place to be and if the market moves to a risk off view, I think money will rush back to big cap tech as sort of a safe haven kind of play. It clearly broke to the upside out of that three month consolidation and 298-300 seems to be solid demand.

 

IWM – What a crazy run in small caps. As stated for QQQ, if the market moves to a risk off environment, the rotation trade from tech to cyclicals could reverse and take small caps down for a much needed pullback and consolidation. There’s an area between 178-182 that should provide very solid support for any pullback, but that’s still a hefty 10% drop. I’m looking to start in short in the 200-205 range, but trying to be as patient as possible. If trading really is thin this week, there could be a nice FOMO meltup area for an entry short.

 

XLF and KRE – The financials are following rates very closely lately. The tech to banks/energy rotation has also been dependable. See if those to correlations continue. If financials start to head down, that’s likely a bad signal for energy. Watch the correlation with IWM and TLT for the financials.

 

GLD and UUP – The dollar continues to weaken and gold finally started to respond positively last week, as did the GDX. I’m not willing to chase gold or the miners up here, but when the dollar does find a bottom, then gold should get a nice pullback for an entry long. Gold also still not following the PDBC (general commodities).

 

PDBC and TLT – Commodities continue to run and have almost moved through that red resistance level I posted on Twitter early last week. As commodities have moved up, rates have tried to keep pace. The TLT tried to break the downtrend line (with GLD) last week but failed and the downtrend (higher rates) continued. If PDBC keeps going up, rates should continue to follow. As rates continue to climb, at some point that could halt the equity run. Inflation could be coming and the only cure for that would be higher rates. I think there could be a battle with the market trying to push rates higher while the FED desperately tries to hold them down. Powell said on Wednesday he wasn’t moving out in duration to try and control longer term rates, but the market really acted as if he were actually doing that behind the scenes. At some point, he’ll have no choice but to extend duration and try to hold those long rates down. Mortgage rates also remain a target for FED manipulation.

 

In summary, the macro picture shows commodity prices moving up (inflation) with most of that being caused by a weak dollar. Rates, in response, have started moving up in anticipation of that commodity inflation. The real question for this market is how high would rates have to go before the equity markets get spooked? The FED has quite a battle on its hands and at some point I think the market wins by forcing rates higher, leaving the FED on the losing end of the stick.

 

Energy

I haven’t been trading energy since December 1. Prices have run so far that there’s nothing I’d buy, but there’s really nothing I’d short either. I think the sector may be digesting the latest gains with another run possible on the horizon. I don’t agree with it and I don’t think the economy warrants another run, but the tech/cyclical rotation could still produce enough moneyflow to push the sector a little further. I think we could possibly get a run at the June highs on the next move, whenever that might be. On a longer term view, I’m bearish on the sector. It’s just too much run too fast and I don’t expect that the economy is going to recover like everyone thinks. Of course fundamentals matter less and less these days as the fast money has taken over the sector. The real key will be the reaction when the economy doesn’t recover, will oil be the first thing to get sold off? Are the recent energy buyers long term believers or just fast money year end players looking for quick returns? Time will tell I guess.

 

The technical picture for the XLE is pretty good. There seems to be good demand in the 36-37 area to stop a pullback. VWAP from November 9 sits around 37.50 and the 50% pullback of this entire move sits around 35.75. If the XLE dropped back under 35, I’d likely be a buyer with a stop around 33.75. If price takes out 32.50, something has probably gone very wrong in the market.

 

Trading Plan for the Week – My primary target for the remainder of the year is a short IWM play. I’m hoping for a gap up on Monday and a run at 200 to start the scale in entry. There could be another 5-10% in this run which could take it as high as 220, but I’m willing to size in at a level where I can take some pain on this one and then add when it starts moving in my favor. The problem that always arises for me is that these shorts move so fast that you need to at least anticipate for part of the trade for a solid average position price. XLE was a great example back on November 9. If you weren’t already in with a partial long, then entering after the gap up was very difficult, especially on the risk control side.

 

My second target is still the ITB. It’s not really acting like I thought it would, but I still think if rates start moving up again then mortgage rates may get caught rising which could make new homes too expensive. If consumers are paying higher rates, then that’s less money they have to buy the house and home prices might need to drop to compensate for those extra interest rate charges. On the other side, commodities are getting expensive and those houses are costing more and more to build. If rates rise and costs rise, the homebuilders could get squeezed from both ends. And this doesn’t even take into consideration the longer term outlook for housing. People are paying some absolutely crazy prices for houses right now. Given unemployment levels, I have no idea how people are affording it. Are banks lowering qualifications? Delinquencies have to be rising in this pandemic environment with so many people behind and begging for stimulus. Houses are incredibly expensive and if the market begins to slow and home prices start dropping, how will the system handle underwater mortgages?  And what happens with this supply of houses if the economy doesn’t recover? I think the homebuilders are priced to perfection right now with growth being seen as linear from here. I’m not sure we learned anything from 2007.

 

That’s really all I have on the radar as the year winds down. It’s been a pretty good year and I’m content just to slide into 2021 and start fresh. No sense in getting hit during a thin holiday market and losing hard earned profits. Much rather spend that time with the wife and family. Hope you guys have all been trading well. Good luck this week.

 

Weekly Energy Review, Market Outlook and Trading Plan for December 7-11

The market has almost reached the 380-400 goal that I’ve been writing about over the last several months. I expect that it will get there in the next couple weeks, but what happens then? This post election and Christmas rally was also expected, but it’s growing old too. One reason I write this article every week is to record what I’m thinking at the time so I can go back and review it to see where I was right and more importantly where I was wrong. The question now is whether or not we get the market reset once the price target has been reached and the celebration of the election is over. Short answer, I think we do, but how big will the pullback be?

 

Last week, I wrote about a possible coming spike in interest rates and we did get a significant move this week with the 10 year almost reaching 1%, while the TLT took a dive toward the June lows. It’s really not a huge market moving event yet, but if rates continue to move up at a faster than normal pace, the market could get spooked and rates could be the thing that causes the next market pullback. I think traders are soon going to start asking WHY rates are starting to climb. The primary answer is inflation. Can the economy in its current condition absorb price increases while so many remain unemployed? And what happens to prices when (if?) the rush of demand returns on a lessening of virus concerns? Where does the money come from to buy all those expensive houses and cars? Stock profits?

 

The one market that really seems to be a concern for me is housing. I really don’t think anyone is paying attention to this sector yet and the signal it is sending. House prices are shooting up everywhere. At what point do the price increases force a move up in mortgage rates, which also track the 10 year Treasury? I know we live in a market of FED manipulation, but there are still real market forces out there called supply and demand. I’ve been watching a short ITB trade for the last few weeks and I think there’s a good chance that sector rolls over if rates continue to rise. If rates do rise due to market forces, then house prices will necessarily have to come down. There’s also the possibility that the market starts seeing increasing mortgage delinquencies as employment continues to lag. Remember how that decreasing home price, rising mortgage delinquency combination worked out about a decade ago? Right now banks are offering the cheapest money ever to buy the most expensive houses ever, that can’t end well. Keep an eye on rates this week and whether the bond market is in fact leading the stock market in direction. The TLT has clearly turned down from its uptrend that started in the fall of 2018, which coincidentally was also the start of the ITB uptrend. Do they now trend down together? Does the stock market soon follow with at least a pullback, if not an extended move down? Don’t ignore the ITB signal.

 

Overall Market Macro

SPY – The move since November 2 now stands at about 15% to the upside. That’s 15 percent in a single month. A single month. At what point do we maybe start considering this to be a blowoff phase in very mature bull market? 20%? 25%? Given all that has happened in 2020, the SPY is up almost 15% for the year. If you knew all that would happen in 2020, would you have taken that bet? Are we melting up in a final move? I think we are and FOMO is running rampant. There are no technicals or road signs on the upside anymore. On the downside, I’m watching 360 and 352. If we do get a meaningful pullback soon, I think the most obvious level would be 322, which is about a 13% move down.

 

QQQ – Tech broke out of the consolidation pattern that started back in August and closed at an all time high. It’s an obviously bullish signal, but could quickly turn into a bearish one if price fails and moves back into the consolidation pattern in the next week or two. Watch price this week and see if it pulls back toward the 295-298 area.

 

IWM – This is my short bet. I’d like to get short in the 190-200 range. This one has just melted straight up from 150 to 188 in a single month to all time highs. That’s a 25% gain in a single month and it’s a textbook blowoff top. I will be getting short this week in a very big way for probably my largest sized trade this year. At some point Main Street and Wall Street have to intersect again. When you look at the real economy, unemployment rates and rising inflation, there’s just no way small businesses should be valued at this level. Is it possible that the short trade is wrong here? Absolutely. But I’ll gladly take this trade and if I’m wrong so be it. I think there’s an easy 10-15% profit in the trade as a pullback likely takes the IWM back toward the 170 level. If it keeps moving up, then I’ll keep adding to the trade up to the 210 level.

 

TLT – The TLT started an uptrend about two years ago, November 2018 and now finds itself testing the trendline from that point, as well as the summer lows of 2020. This is probably the most important watch of the week. If it takes out the 153-154 area and gains speed, the stock market may get a shock from rising rates. If it bounces, then 161 becomes the target on the upside which could establish a short term bottom in rates. I think there’s a real possibility the market is taking rate decisions out of the FED’s hands and that could cause the stock market some stress.

 

UUP – The dollar continues to weaken with the UUP falling, but there could be support coming soon around the 24-24.25 area. Rates and the dollar are currently competing against each other with regard to the effects on commodities (PDBC). The weaker dollar is pushing the PDBC up, while rising rates are a response to that commodity inflation. Who wins? At this point, I think the market would prefer the dollar to find a bottom soon in hope that commodities would slow their rise, which in turn would likely slow the current rising rates. If the UUP continues to fall at its current pace, then the TLT likely follows and rates continue to rise, which eventually ignites a stock market pullback.

 

PDBC and GLD – I watch general commodities through the PDBC. There are several different ETFs which measure general commodities, but PDBC has the most liquidity. If you place the PBDC and UUP charts side by side, the inverse correlation is obvious. As UUP falls, PDBC rises. PDBC contains an large weighting in oil and energy, so it does reflect the XLE chart somewhat. The current PDBC move up is reaching a very strong resistance level around 15.00 which started back in 2016. If it breaks that long standing level, inflation concerns will only grow. I think it will break that level. Another clue is the XME, which measures industrial metals and gold. It has moved from 24 to 32 (with gold components negative) in the last month, which is a signal that other general commodities may not be far behind. The one commodity that isn’t cooperating though is GLD. The UUP has moved down sharply, the PDBC up, yet GLD has fallen since August, along with TLT. It should be going up, and up sharply. There’s an argument that traders are bailing on it as a safe haven play and it’s no longer wanted after the vaccine news, but the inflation angle may kick in soon and start pushing it back toward the 195 highs. I started a GDX long on Friday and I’ll be adding to that position if gold does start back up.

 

So when you put this macro picture together, what we currently have is rising commodities (inflation) being caused by a weak dollar, which in turn has set rates off to the upside with that commodity inflation. And this negative cycle is going on in a pandemic environment where unemployment is at record levels and people are getting behind on their mortgages, rent and other obligations. The real question is how far do these intermarket forces go before they put a stop to the current bull market in stocks? How long can the stock market ignore real world forces? And what happens if you throw in rising gasoline prices, rising food prices and higher taxes? At some point, this fantasy world of Wall Street is going to have to acknowledge the reality of Main Street, but as usual, the opportunity for us as traders to take advantage of this always comes down to timing.

 

Energy

Sorry that macro review was so long, but that is where most of my attention has been focused over the last month. You have to know where you stand in the larger picture before ever thinking about the narrow energy sector. So how does energy, and the XLE, fit into this macro picture?

 

As general commodities have risen, so too has the USO. This rise in the USO has been helped along by a weak dollar (specifically the USD/CAD pair), and all this has pushed the XLE from 28 to 41. The sector has also been helped by a rotation trade out of tech (QQQ) and into financials (XLF) and energy. With regard to the larger macro picture, the question for XLE now is how long does the weak dollar and rising PDBC propel the USO, and how long does the rotation trade cause money to flow to energy? If the SPY does have a pullback, how loyal are these recent new longs in energy going to be? Will they throw it all back on the market at the first sign of a pullback or are they long term players? I really don’t know if this energy move has been just a year end fast money play looking for quick returns or if these traders really believe in a long term future for fossil fuels. I think we may get the answer to this question in the next month or two.

 

On the technical side, XLE has now run 50% in the last month. I’ve seen some good runs in energy over the years, but this is top 10 for sure. I really have no idea how far this goes, but I do think it needs a pullback soon if it wants to establish a dependable long term trend. If this just shoots straight up, the buyers from lower levels are just going to bail and take sizable profits, which leaves many bagholders. I’d much rather see a pullback and a grinding type uptrend than this parabolic move. The XLE is now reaching that early June blowoff area and price could possibly test those highs around 45, but again, the real problem is what kind of structure is it building underneath with this parabolic kind of run? As we saw in June, the parabolic run had absolutely nothing under it, so is this a repeat?

 

I’m definitely getting interested in a short position in energy soon and it think the opportunity could present itself this week with a simultaneous blowoff in the XLE and IWM. I started a very small short position at 40.50 and I’ll continue to build that position up to the 45-46 area. I have absolutely no desire to get long any individual names way up here. We still have a pretty pathetic economy and there’s no guarantee this vaccine produces the pre-pandemic demand levels. There’s still a huge supply of oil sitting just over the market which has been building over the last eight months. These companies still have tons of debt, bad fundamentals and a current group of declining wells which will need to be replaced. CAPEX is going to have to increase soon if those wells are to be replaced to prior levels of production. Do these companies have the money to increase CAPEX and what does that do to their cash flows? That has always been the problem with shale, they have to replace these quickly declining wells so quickly that CAPEX eats the profits.

 

One other thing to watch for in energy is secondary offerings. As the equity market continues to advance, individual energy names will surely take this opportunity to come to the market for funds. That dilution could really make some names dangerous, especially the ones who are already weak and need the funds the most. I’d recommend staying away from the lower quality names for this reason.

 

In summary, this energy run has been nice, but is there any future in it or has it just been a quick money trade in the final blowoff of a very mature bull market? I’ve always seen this market cliche that when energy is your leading sector, the end of the bull market may be at hand. I don’t know if it’s true this time, but given the larger macro picture, I wouldn’t be too surprised if it was. Be careful and really consider the risk you are taking if you get long on these names after this gigantic run.

 

Trading Plan for the Week – I have only four targets this week: short XLE, ITB, IWM and long in GDX. I’ll be focused on these four and I won’t be trading any individual energy names or any other sectors.

 

I’m looking for a move up in XLE toward the 45 area to build a short position. I’m willing to stay in this position for awhile and incur some pain in it. While I would like to think the energy sector has bottomed, there are just too many other larger factors that say this is just energy getting swept along with the larger market and not a specific move based on the internal factors of the oil market or the fundamentals of individual energy names. Target on the play is 32-35.

 

I want a short in IWM in the 190-200 area this week on a parabolic move. The key here is to watch the QQQ/IWM correlation and hope that money reverses flow back to tech and away from small caps, banks and energy. Any acceleration to the downside for TLT would also benefit a short play. Target on the play is 170.

 

I’ve already tried the ITB short and made a small 3% gain, but price hit my trailing stop and knocked me out late last week. This is still my favorite trade opportunity in the current market.  I was hoping for a nice retracement back to the 56-57 level as the SPY made new highs, but the ITB really couldn’t muster any strength at all, which tells me a short is the correct play. This short play depends strictly on the TLT. If the TLT finds a bottom this week, I’ll probably avoid the ITB short play for now. The reason behind this play is that mortgage rates should follow the 10 year yield up, which will force house prices down. Also, as copper, steel and other building materials increase in price, builders aren’t going to make the normal profit margins, especially if house prices fall due to increasing mortgage rates. It’s a really dangerous combination of rising input costs and rising financing costs, not to mention the employment and consumer debt picture. With this current economy, how are banks able to approve this flood of buyers, especially at these high prices and low rates? Are requirements being relaxed like they were in 2007?

 

The last trade on the radar is a long in GDX. This is the tricky one of the group. I started a long at 35.25 on Friday for a short term trade, but I’d really like to see this fall to the 30-32 area for a longer term play. As inflation starts to become a threat and the dollar continues to fall, gold should soon find a bottom. I think there could be a nice entry window when the dollar finds that first temporary bottom. Usually gold and the dollar move inversely, however GLD has been moving down with UUP and TLT. If we suddenly get a strengthening dollar, that could send GLD/GDX down sharply. If gold is moving down on a weak dollar, then it makes sense that it should move down even faster on a strong dollar. If this happens, then that’s your entry. The window will be very small and will look extremely scary, but you have to plan for it and execute without thought when it happens.

 

That’s the plan for the week. It’s mostly going to be a week spent waiting and watching for these four setups to form optimally. This is a dangerous market and FOMO is getting out of control for the crowd. Watch sentiment and be ready for the turn. This could be the final blowoff in a very old and very extended bull market. Good luck this week.

Weekly Energy Sector Review and Market Outlook

Hope everyone had a great Thanksgiving week. It was a nice vacation and some much needed time off. I’m ready to get back to trading this week. Before jumping into the regular top to bottom energy macro analysis, I took a few minutes this morning to examine the areas that were NOT moving this past couple of weeks. Sometimes the clues don’t come from what is moving, but rather what should be moving, but isn’t.

 

There are a few areas of the market that might be offering some signals for what we might see in the next few weeks, specifically Homebuilders (ITB), Mortgage Securities (MBB) Utilities (XLU), Gold Miners (GDX) and Real Estate/REITS (XLRE). As the overall market has advanced sharply, these areas have lagged or even moved opposite the larger market picture. The question is, what are they trying to tell us?

 

The common theme among these sectors is interest rates. The fact that these sectors are fighting the overall market direction means that something is holding them back and I think that something is a coming increase in interest rates, which could be a warning for oil and equities. The most common interest rate indicator I follow is the TLT, which represents longer term rates and also has the most bearing on inflation. It’s an interesting picture if you compare the TLT chart with the TIP chart. I think the most sensitive sector out of the handful that I have chosen is the homebuilding sector (ITB). That chart really looks like it might be about to top out and roll over and that makes perfect sense if you assume that interest rates are about to rise sharply. Higher mortgage rates make houses more expensive and less obtainable, which may be why this chart looks to be putting in the famous head and shoulders formation. Real estate (XLRE) is the same and of course utilities (XLU) is not something you would want to own in a higher interest rate environment either. Of the eleven SPDR S&P 500 sector ETF’s, utilities had the worst performance since this market run started on November 9.

 

One curious area that requires attention is mortgage securities. The largest ETF for this is MBB. That instrument has been falling since May and that’s even with the FED buying heavily in that ETF. They are trying to hold price high (rates lower) to promote homebuying, but the instrument is still moving down. If rates start to accelerate to the upside, this one could fall sharply and take ITB down with it. One other thing that I thought was interesting is that if you look at mortgage rates these days, the 30 year fixed rate is LOWER at some banks than the 5/1 ARM. That just shouldn’t be, but I’m not exactly sure why this is happening. Are banks (or the FED) discouraging ARMs?

 

These hidden interest rate warning signals that are flashing in the market need to be respected. If rates are about to spike, and I’m not saying they are, then risk management in equities needs to be tightened and extreme caution used. If anything is going to bring this market down, it’s a spike in interest rates, whether market forced or FED forced.

 

Macro Picture for Energy

With that warning out of the way, let’s take a look around the macro picture for oil and try to figure out what to expect this week. The SPY just continues to grind higher and the QQQ decided to join the party last week by breaking out of a pennant type formation which started back in August. I think the more important indicator of the two for the energy sector is the QQQ. If tech really breaks higher this week, the tech to cyclicals (XLF/XLE) trade could pull back sharply and force the XLE to pullback and digest some of its gains. If the QQQ fails and heads down this week, then it’s possible that the XLE could grind higher. The real question here is how long does this tech to cyclicals rotation continue?

 

One clue for the rotation can be found in the other cyclical area that has been climbing along with energy, the XLF. The banks have a benefit that the XLE doesn’t have and that’s higher rates. As rates climb (TLT down), financials perform much better on margin interest income. This week it will be interesting to see if the XLF and XLE finally start to diverge. If rates stay flat or rise and the XLF starts to fall, then I think you have to get out of energy in the very short term. However, if there’s any divergence where financials fall and energy grinds higher, that would be an incredible show of strength by energy.

 

The next clue for energy is the IWM. Small caps have been the strongest part of the market and have correlated very well with energy for the last several months, but at some point this run needs a rest. During the month of November, the IWM has moved from about 151 to 185 and that’s an extreme move for such a larger portion of the market. I wouldn’t be surprised to see a pullback to at least the breakout point around 170. Since the IWM and XLE have been so correlated, any pullback in small caps should be accompanied by a pullback in energy. Keep an eye on the QQQ/IWM correlation to see which is stronger as an indication of the tech to cyclicals rotation. If QQQ opens the week strong while IWM lags, then it’s probably time to get cautious on the XLE.

 

I base my macro market view on correlations, but one important thing to know about this approach is that correlation DOES NOT equal causation. As I compare all these different market areas, I’m not saying that all these moves cause or are caused by other areas. The only goal is to use these correlations to notice when things change or when relationships don’t make sense. The underlying “why” is often very difficult to ascertain. As an example, one correlation really has me stumped right now and that’s the Dollar (UUP) to Gold (GLD) correlation. The weakness in the dollar has been providing a tailwind to oil lately and that same tailwind should be showing in gold, but it’s not and I really can’t explain why. A weaker dollar should indicate higher gold prices, especially since other general commodities (PDBC) are rallying on the weak dollar. Gold is suggesting that the dollar may be getting ready to firm up and bounce in the near future, and if it does, that could be a warning for oil. I posted a UUP/USO side by side comparison chart Friday which shows an almost perfect inverse correlation. If UUP starts to move up, then USO should start down.

 

One other relationship that might also be offering clues is the TLT/GLD correlation. They have moved together for months and what we have been seeing is gold moving lower on rising rates, yet other commodities are moving up. The GLD/PDBC divergence is confusing. If there really is a chance of inflation picking up (as indicated by rising rates) then gold should be moving up with the other commodities, yet it’s not. The only other reason might be if the recent GLD rise was heavily caused by a safe haven type of trade. There was a fairly large gap down in GLD on the November 9 vaccine announcement. That’s really the only reason I can show for why gold has diverged so much from general commodities. The important factor to keep in mind here is that gold could be leading the other commodities, so keep an eye on the PDBC to see if it turns down along with any move up in rates.

 

In summary, the clues are pointing to a pullback in energy this week. If the UUP bounces, the TLT rises, XLF falls, QQQ rises, IWM falls or USO falls, then energy names could get hit. A positive picture on Monday morning would be a flat QQQ, higher IWM, lower UUP, higher XLF and a lower TLT (although TLT is the tricky one).

 

Energy Sector Technicals

I’ve stayed away from individual energy names over the last couple weeks. The only trades I have on right now are a short on the XLE with an average of 39.90 and a long on GDX with an average of 33.50. I’m still scaling in on these, so I’ve only got partial positions right now. I think the XLE finally pulls back this week, but I’m not sure how much. The most obvious level for any pullback is the 35.50-36 area. That would correspond with the gap up last Monday and last week’s lows. It would also correspond with the VWAP from the November 9 move which sits at 35.50. If you average all the buying since November 9, the volume average weighted price is 35.50, so that’s a pretty strong indicator of fair value. That fair value level would also be about a 38.5% Fibonacci pullback of the November 9 move. If the sector truly is strong and this isn’t just a fast money rotation trade, then price really shouldn’t drop any lower than that.

 

The next level down in the XLE would be the 34.50 area, which corresponds to a little over 50% pullback of the recent run. If that level fails, then the sector is probably in trouble and the only level that can save the day is the 32-32.50 area. It would pretty much be a complete disaster if 32 failed at this point. Something really bad would have to happen to cause a move back into that November 9 gap. Maybe an OPEC meeting surprise?? If XLE gets back in that gap, I’d say it’s probably headed for new lows, however I really don’t see much chance of that happening.

 

On the upside, the first level to watch on Monday is last week’s high at 40.42. The only important area above that is the 41.86 (Friday March 6 OPEC meeting gap) to 41.93 (June island reversal) area. If price can clear that small range area, there’s really nothing stopping a run for the June highs.

 

MajorsXOM continues to lag CVX. These two have traded near 2:1 in price, however CVX has recently extended that to 91:40. Perhaps the difference in opinion has been caused by the CVX still be indexed to the Dow as it surged past 30,000. RDSA has been the second strongest, while BP is dragging up the rear again. I still like XOM for a longer term trade, but I really need it to pullback significantly to get interested. I’d be interested in the 35-36 area.

 

E&P – These have just ripped over the last three weeks and there’s nothing attractive about these prices. They are priced to perfection right now and the only people who could profitably touch them at this level are investors who plan on trying to capture a multi-year run, and that’s definitely not my style.

 

Services – Same story as the E&P’s only more so. The only possibility that I see for a shorter term trade is NOV on a pullback to the 11-12 area. SLB, HAL and HP have all run so far that buying at these levels in the short term just isn’t possible.

 

Refiners – This was the trade I wanted the whole time, but I missed it. The group will be my primary watch if the sector pulls back in the coming weeks. I really doubt that I’m going to get a buyable pullback, but I’d be interested in MPC in the 33-34 area, VLO 48-50 and PSX 55-56. The vaccine news really treated these well since they are closest to the actual consumer.

 

Trading Plan for the Week – I’ve got my XLE short position and I’ll probably spend Monday just watching that to determine whether a pullback is actually in the cards for energy or if price is going to grind higher. We’ve got an OPEC meeting this week and the March meeting is still a fresh wound for many traders, so I expect that traders will be cautious early in the week. The price action might take until Wednesday to take a defined direction, so the best move this week is probably patience. If price grinds higher, I’ll just let it climb and continue to scale into the short up to 43 as planned. If we get a gap up and fail, then price is probably headed down for the week. This week really all depends on the OPEC meeting and the macro factors discussed above. The dollar, tech and rates will control the picture. I won’t be trading any individual names this week, as I’m more focused on the bigger picture for the month of December. I usually taper down my trading during the first two weeks of December and then take a couple weeks off at Christmas.

 

So, not much to do in energy this week, but there are other opportunities in other sectors. I’m definitely considering starting a short position in the homebuilders (ITB) and some of the associated housing services like Z and RDFN. Some suppliers might also be attractive like MAS and LPX. Two names that might also be interesting for shorts related to the homebuilders are HD and LOW. Specifically, HD is sitting right on a nice support area that corresponds almost exactly with the support area in ITB. Those two could break lower together or even offer a long trade if the downside break gets solidly rejected.

 

I’m also long GDX, but I’m really not crazy about that position right now and I’m probably not going to add to it this week. I’ve got an average price on the trade of 33.50 and I’ll probably put a breakeven stop on it there for the week. If it takes that level out, then I would imagine it will make a move toward that 30-32 area for a better trade.

 

I don’t often get involved in tech, but AAPL is a watch this week as it continues to wind tighter in a consolidation pattern. I think this becomes attractive in the 108-110 area for a long play, but with very tight risk control and if it takes out 105 you have to let it go.

 

My last watch this week is the USD/CAD pair. I’m looking at getting long for a bounce in the dollar. If I can get something under 1.2950, I’ll probably start scaling in for a move up. As I said before, gold and rates are giving the signal for a stronger dollar, and oil is stretched to the upside, so price could be getting ready for a big move up in the USD/CAD.

 

It’s Sunday morning and I’m off to get a Christmas tree with the family. It could be a really slow week and energy might be a bit disappointing, so it’s one of those weeks to be really patient and let things play out. Keep tight control on the risk. Good luck this week and be safe.

Weekly Energy Review and Some General Trading Thoughts

What they say about trading is true, it isn’t you against the market, trading is a battle with your own mind. Anyone can read a chart and recognize where the levels are and what direction price is heading. The real trick is being able to trade that external chart without your own internal bias interfering. I’ve managed to mostly win that battle over the years, but I’m definitely not undefeated during that time and the last couple of weeks I have lost that battle. I know which way price is going and what the chart clearly says, but my mind has a totally different opinion about what is going on in this market. As I said in last week’s writeup, I am conflicted, but standing aside and just watching the action this week has been incredibly helpful. I’m probably not ready to jump back in head first, and I’ll be taking this holiday week off as well, but I’ll definitely be sticking a toe back in soon. Sometimes the correct move really is to step back, take a deep breath, organize yourself and then proceed.

 

In trading, one of the more troublesome biases isn’t really a bull or bear bias, but rather a recency bias. Let me see if I can explain this clearly, because it has been a problem that I’ve encountered in the past that might help someone else. I mostly daytrade a single sector and sometimes when you get so focused on what is currently happening in the day to day moves, you lose sight of the larger picture. Sometimes you expect the most recent moves to be the true and correct price, when in fact the bigger picture has changed, or was always wrong. If you continue to anchor your thoughts to the most recent prices, you miss the larger picture moves because you can’t change your view.

 

I think what has happened to many traders, myself included, is that we focused on the day to day energy stock prices and anchored ourselves at ridiculously low price levels and we began to accept those prices as true and correct, when in fact they may have never been correct to begin with. However, if you focus on something day after day after day, you forget to even ask yourself if those prices are correct, you just trade them on the assumption that they are correct. When you do this, you leave yourself susceptible to larger market moves like we saw in energy the last two weeks. That move from 27 to 37 was ridiculous, or was it? Maybe this group was always underpriced, yet we focused so much on the recent day to day fluctuations that we never saw the bigger changes. We set our mental price anchor at a level that wasn’t correct. And then the price adjustment happened all at once, not because of some great change in the fundamentals, but because the overly depressed price was never correct to begin with.

 

I think that was my mistake with this most recent energy move and the reason I didn’t catch it. The fundamentals of the energy sector haven’t changed, yet the price changed in a very big way, and that caused a very big conflict in my trading and put me off my game. Many times when we trade, we expect a change in fundamentals to produce a change in price, yet the opposite isn’t always true. The only way to fix this kind of conflict is to take a break and move up a level to the bigger picture. Pull up the anchor, look around and get your bearings, set yourself and then put the anchor back out based on the new market information.

 

My second mistake was becoming fixated on how the overall trend in the market SHOULD change. I knew there was a trend change coming and if you read the last couple months of writeups I have been looking to get long in a big way for the coming move up. The mistake was that I thought this market downtrend would end with a final washout to the downside with an extreme volume capitulation that would wipe out all the weak supply and allow the market to then trend up. But instead, the downtrend ended with an extreme gap up on incredible volume that wiped out all the weak supply, thereby allowing the market to trend upward. That gap up change in trend is not common and it really isn’t something that you can practically trade. But it does occasionally happen. If you go back and look at a thousand charts, you won’t find this type of trend reversal in very many of them.  As a trader, all you can really do is trade things that are tradable, like a downside washout. There really just wasn’t any way to know that the market would change with a high volume gap up. You trade what you can and don’t beat yourself up too much about the moves you miss, because they weren’t catchable to begin with. Had the sector made a high volume washout to the downside, I was there, but it didn’t so all you can do is let it go.

 

Success in trading isn’t necessarily about catching all these big pivot moves. The real trick to staying in the trading game is the skill to be able to adjust to the big pivot moves (and avoid the adverse side of them) and then re-enter the market to resume normal trading. And even if you do get caught on the wrong side of big pivots, the true skill needed to survive is the ability to withdraw from the market and re-evaluate. Simply take a break and get your head right. I’ve found that trying to power trade through these moves with shaky psychology never works. Some people can adjust quickly on the fly, but I know that isn’t a strength of mine. I know I have a weakness in that my overall view of certain markets is sometimes slow to adjust. Taking a break is really the only move to protect against that weakness. There’s no shame in taking a step back, clearing your head and then coming back, the market will always be there.

 

So where does the energy sector go from here? The XLE has recovered about five months of selling in about ten trading days, so naturally the correct assumption is that it’s due for a pullback. The depth of that pullback will tell a lot about the true health of the energy sector. At this point, I have no desire to chase price up here and I’m content to sit and let the pullback happen and then make a decision about what to do. I think if you chase this rally, the trades become extra expensive and highly risky. The market is hyper sensitive right now. What if there’s a disappointment in the vaccine or some other external negative event (there are still unknown unknowns out there)? I could see the XLE easily giving up half these gains in a single gap down and that’s not a risk exposure I want.

 

Technically, there’s also a chance that what we are seeing in the sector is a larger picture accumulation rather than a true trend change. We got the selling climax back in March, an automatic rally in April/May, then a pullback to retest the selling climax lows in September/October. We could be looking at a long term sideways range between 30-40 for the next 6-9 months. We’ve had the big price change, now I think traders could take a rest and see if the fundamentals adjust also. If things get better in energy, there should be price discovery above 40. If things start to drag again and the lockdowns dampen the economic picture, then I wouldn’t be surprised to see price come back down and test the bottom of the range around 28-30 again. As for whether the lows are now in, I really don’t know. I do know that my view has adjusted. A few weeks ago it was my opinion that we had NOT seen the lows yet, but that gap up wiped out a huge amount of weak supply, so are there really that many sellers left that could take it down? On the other hand, that buying was likely concentrated in a few buyers, therefore if they do stop buying, or worst case if they start dumping it back on the market, then how far down do we go? I still think there is a chance that the low isn’t in, but that chance is much smaller than it was before the big gap up a couple Monday’s ago. I’m just not ready to say the lows are in yet, because if this really is a larger picture accumulation, then there will be a shakeout before the real and final trend up.

 

The Macro Picture

The week off has been informative. I’ve focused strictly on the bigger picture macro all week and have noticed a few things. The most important thing in this market right now seems to be which direction the dollar wants to take. It’s at an important pivot point and the next move will likely control equity market direction for the next several months. So many individual currencies are at longer term inflection points and this could impact stocks. Pay attention to whether the media starts to focus more on dollar direction in the coming weeks. The UUP has been forming a large base near lows since late July and closed Friday right at the bottom of that base at 24.93. The UUP has trended down (weak dollar) since March 23 while the SPY has trended up since March 23. What happens if the UUP breaks out of this base to the upside? And if you look at the QQQ or SPY charts, they too have been in somewhat of a base, just like UUP, near highs for the last few months. If UUP breaks out of its low base and trends up, does that signal that SPY/QQQ will break out of their high bases and trend down? How much of a headwind would a strong dollar be to US stocks?

 

If the direction of the dollar is important, then what clues might tell us which way it is going to break out so we can position correctly with stocks? The most dependable correlation with the dollar is usually GLD and GDX. The falling UUP (weak dollar) has pushed GLD straight up since March. If the correlation remains true, then a move up in UUP should produce a move down in GLD. However, if you look at GLD and GDX, they have already topped out and have been moving down. The AUD/USD specifically could also be topping out in the .73-.74 area, which would be a further negative correlation for GLD. Is this failure by GLD (and AUD/USD) an early signal that the dollar is about to strengthen (UUP breaking out to the upside)?

 

The EURO is the most prominent currency in the DXY, and just like the UUP has been stuck in a base since August, the EURO has also been stuck in a base during that time. Watch that 1.19 level for a breakout or rejection. If 1.19 fails again, then 1.16-1.1650 becomes the downside watch. The GBP is also looking at a big breakout level around 1.34-1.35. If it fails there, the pullback could be sharp. The YEN is really trying to base around 103.50 and if it does there’s a big downtrend line from 2015 that could be broken for a huge move back toward 1.10. The weak dollar has been an important tailwind for the SPY over the last few years and I really don’t know how it will perform if the dollar changes direction. All I do know is that many of these currencies are at really important inflection points and that could have a large impact on the future direction of stocks.

 

With currencies in mind, watch the USD/CAD this week. Much like the AUD/USD offers clues for GLD, the USD/CAD does much the same for USO. The CAD is sitting on a major level around 1.30 and could make a big move soon. That major 1.30 demand level for the CAD corresponds to major upside supply level of 43-44 in WTI (29.50 in USO). A breakdown of this 1.30-1.34 range would be a positive signal for oil, however if 1.30 holds and the CAD starts upward along with strength in the UUP and currencies above, then commodities, including WTI, could suffer. Keep an eye on the CAD/USO correlation over the coming weeks.

 

Besides the currency and commodity correlations, the TLT could be offering some useful signals for stocks as well. If we go back to November 9, which was the day XLE gapped up, the TLT has been moving straight up since then and now appears to be trying to break out of its larger picture slow grind down which started early August. Also, notice that GLD also started it’s slow grind down on the same date as TLT. Bonds and gold may break back to the upside together (implying a weak dollar), which could be a good signal for stocks. While these correlations can diverge at any time, they do offer good background signals. The divergences themselves can also offer good clues.

 

As for the equity indices themselves, SPY and QQQ remain in a consolidation, however the IWM has broken to the upside. The important watch this week will be how IWM handles a pullback to the breakout point around 170. The QQQ continues to evolve into a tightening triangle since topping out in early September and the upside points to watch there are 294 and 300. For the SPY, much like the IWM, it should pullback toward its recent breakout point around 350-355, at which point it will offer some good clues about the underlying strength and whether or not this election/Christmas rally is out of steam. While I don’t think there’s any real danger of a big breakdown in any of these indices, they could fall back into a consolidation range and be very difficult to trade.

 

I think the most important stock sector this week will be the financials (XLF and KRE). The pullback in TLT, which began back in August, has fueled a nice run in the bank stocks, but it will be interesting to see if a larger picture move up in the TLT (lower rates) will stall that run in the banks and move money back to tech. It’s difficult to determine how much of this move in financials has been due to the tech to banks/energy rotation and how much has been due to rates creeping upward. Banks and energy stocks have moved together on this latest move up, so if financials start to diverge to the downside, that could be a signal that energy could be running out of steam.

 

As for energy itself, I really tried to divert my attention from the individual energy names and keep my focus on the larger picture last week. It’s been an amazing run, but the XLE is hitting that summer range and also the 200 day ma, so it may be time for a pullback to see just what kind of demand is now under this sector. The levels on the downside to watch are 35 (last week’s low), 32.50 (prior week’s low) and 30 (original demand level for this entire move). There’s also a minor level around the 50 day moving average around 31.25, but if price falls that much this week I doubt that level would stop anything. I don’t have any trades setup this week, but if price somehow makes a crazy move toward 40, I’ll start in short. If we get some type of major pullback, I’d be willing to start in long at 30. Like I pointed out earlier, we may be looking at a longer term consolidation range of 30-40 over the next few months, so playing the edges would be attractive.

 

I’ll probably stay off Twitter again this week, and honestly it’s been a great break from the distraction of social media. Sometimes I think we don’t realize how much mental energy we waste on social media. It has its purposes and can cure boredom, but often those advantages are heavily outweighed by the disadvantages of distraction, anger and confusion with the opinions of others. So I’ll be watching the big picture again this week and I’ll pop on Twitter if I see any good trades in the macro. Hope you guys have all been having good trading results and I wish you a Happy Thanksgiving with your families.