By Editor – September 09, 2022 8:00 am CDT
As you, a regular reader of my reflections here and elsewhere, will know, I generally prefer a contrarian style of trading. This comes from years spent in the interbank FX market, where the intraday nature of most desks’ trading meant trades filled very quickly. Once a move got underway and gained momentum, it wasn’t long before nearly all were positioned the same way, a situation that skewed the risk/reward trade-off in that direction. When everyone is short, there are few left to sell, and even a small move higher can trigger a panic rush to exit…a classic short squeeze. And the same could happen vice versa if everyone were buyers.
However, oil is not a currency.
If you are short a currency on a forex trade, you are necessarily long the currency on the other side of the trade. For example, if you buy USD/JPY, you are going long dollars, but at the same time short the yen that you used to buy those dollars. That means you’ll have to cover that succinctly at some point. However, with oil, one side of the trade is a commodity…it can be used and consumed and is subject to fluctuations in supply and demand. For example, when economic conditions are bad and demand falls, suppliers still have to sell their production, and at lower and lower levels, rather than having a major inventory problem.
This means movements can be sustained for longer, and due to current conditions…
As you, a regular reader of my reflections here and elsewhere, will know, I generally prefer a contrarian style of trading. This comes from years spent in the interbank FX market, where the intraday nature of most desks’ trading meant trades filled very quickly. Once a move got underway and gained momentum, it wasn’t long before nearly all were positioned the same way, a situation that skewed the risk/reward trade-off in that direction. When everyone is short, there are few left to sell, and even a small move higher can trigger a panic rush to exit…a classic short squeeze. And the same could happen vice versa if everyone were buyers.
However, oil is not a currency.
If you are short a currency on a forex trade, you are necessarily long the currency on the other side of the trade. For example, if you buy USD/JPY, you are going long dollars, but at the same time short the yen that you used to buy those dollars. That means you’ll have to cover that succinctly at some point. However, with oil, one side of the trade is a commodity…it can be used and consumed and is subject to fluctuations in supply and demand. For example, when economic conditions are bad and demand falls, suppliers still have to sell their production, and at lower and lower levels, rather than having a major inventory problem.
That means moves can be sustained for longer, and based on current conditions, we now appear to be in one of those large, sustained moves that represent a fundamental price adjustment. After all, we are in the midst of a fundamental reorganization of the situation. On Thursday morning, the ECB joined the Fed in the 75 basis point club as it announced a three-quarter-point rate hike, the largest in that institution’s history.
Central banks are determined to rein in growth to fight inflation and have been loud and clear that they will not stop raising interest rates until data shows they have succeeded. That sounds classy and resolute, but when you consider that the data points they talk about are all at least a month out of date when they’re released, and that the Fed and ECB typically rely on a three-month moving average of that outdated information, there is an obvious problem. If they stop raising interest rates, they will likely have pushed Europe and the US, and almost inevitably the world, into recession.
So I don’t do anything of the sort, even though the WTI futures (CL) chart has an appearance that would often make me want to find a bottom; in fact, I still trade with a pronounced short bias.
For those unfamiliar with this expression, this does not mean that I am short all the time or that I never go long intraday. What it means, however, is that when I go long, I set fairly tight stop losses and, win or lose, I always exit the position before the day is out. Profit targets on longs are also closer than normal and when they are hit I’m out regardless of momentum level or other factors that might eventually cause me to readjust stops and run the position. However, shorts have looser stops and a greater likelihood of staying overnight, with a stop reset and at most a partial cut being the normal response to hitting a target level.
Since the beginning of June, there has been a major move lower in Crude Oil, the kind of move that usually piques contrarian interest in me. However, not now. The world’s central banks are actively trying to slow down economies and the way they are doing so makes it likely that they will go too far, making further losses in oil prices far more likely than any kind of reversal.