When is the oil rebound coming? Nobody really knows, but we have to be prepared to take advantage of these historic lows.
There are some interesting trades setting up, which are once-a-decade type opportunities. But with big potential profit, also comes big potential losses.
In this post I will go through seven potential opportunities that I believe can be monster oil-related trades. But only if you play them right.
Disclaimer: Information in this post are personal opinions, is for educational use only and is not trading or investment advice of any kind.
The Dangers of These Trades
When markets get to extremes, it is easy to start to try to pick tops and bottoms. But as the saying goes…
The market can stay irrational longer than you can stay solvent.
– John Maynard Keynes
This is how traders blow out their accounts. They go all-in on an idea and say: “price is going to turn around…here!”
Picking your all-or-nothing price is like putting yourself at the edge of a cliff.
Then of course, price stops them out (or margins them out)…and then immediately turns around in the direction that they initially expected. They whip out their calculators and see how much they would have made with their previous position.
For the next 10 years, whenever the topic of trading comes up at a party, they will tell the story of how they almost made a fortune once.
Let's not be that guy (or gal).
So if you choose to trade these oil rebound opportunities, plan your strategy with some room for error.
…actually a lot of room for error.
Crude Oil Analysis
Everyone is talking about how low oil prices are and people are already trying to pick bottoms to catch the oil bounce. First, let's take a look at the monthly chart.
The question becomes, where would be a good turning point in the market? If we look at the chart, it looks like $16.58 would be a reasonable support level (magenta line).
As you can see, that level was an important support and resistance level throughout the 1990s and into the early 2000s. So it stands to reason that that level could become important again.
But keep in mind, oil can hit that level, dip well below it, range around for awhile, then finally move back up. $8 oil is also a possibility, no matter how unlikely. The price could also never get below $20.
So while it might be tempting, we should not expect a V-bottom rebound and we should certainly not pick an exact turnaround price.
Technical analysis aside, what else do we have to consider? I'm generally not too interested in fundamental analysis, but in this case, I think it is smart to keep an eye on what is going on.
Let's face it, our need for oil isn't going anywhere soon. Even though there are a lot of impressive renewable energy projects on the horizon, the demand side of the equation will largely remain intact.
With falling oil prices, a lot of oil companies are having trouble turning a profit. Therefore, oil mining operations will shut own, companies will go out of business, smaller companies will get bought out and supply will decrease.
Be sure to keep an eye on the oil news, to get an idea when supply might start to tighten.
But the oil rebound will take time. Things won't turn around immediately.
It's like trying to turn a cargo ship, not a speed boat.
How to Take Advantage of the Eventual Oil Rebound
There are a few different ways that you can play this, depending on your risk tolerance and knowledge of different trading markets.
But here's the basic idea…
Regardless of which market you trade, profiting from the oil rebound is going to take some strategic trading.
I'm sure the question is going around in your head right now…but what if I wait too long and totally miss the bottom?
The key to taking advantage of this oil rebound opportunity, will be scaling into the trade. This is something that many professional traders do and something that Rafael does and teaches in his course.
In fact, I recently met up with him recently in Toronto and we talked about these opportunities over some killer pizza.
I'm going to start with ETFs because there is a lot of misconception about how to play oil ETFs in this downturn.
A lot of people incorrectly assume that buying and holding a leveraged ETF at these levels, will make you a fortune. For example, if you buy UWTI below $1 and you hold it to its historical high of about $600, you will be rich.
You would be rich…if that is how it worked. But it is not.
If it is too good to be true, it probably is.
You see, leveraged ETFs have to rebalance their portfolios at the end of each day, in order maintain their goal of a certain multiple of daily underlying price movement.
That means that there are significant transaction costs associated with the daily operations of the fund. Costs that investors pay for. So the longer you hold an ETF, the more transaction costs you incur.
The current price might actually be higher than your initial purchase price, but you may have paid for enough fees to make your net position a loss. This is greatly magnified during periods of high volatility.
To learn more about how this works, read this article on why investors lose money with leveraged ETFs.
Therefore, you should not hold the position for more than a few days. Ideally, you should only hold it for a day or two.
But there is still some opportunity here.
As you saw in the $UWTI chart above, we are at historical lows for the ETF. In fact, there should be an opportunity to buy the ETF for less than a dollar, very soon.
This significantly reduces your downside and will give us the opportunity to hold for a few short-term pops.
You can also use this ETF to take advantage of pullbacks. Just be careful of trading at higher prices because there is more to lose and you could easily give it all back.
To get a more comprehensive list of both long and short Oil ETFs, check out the ETF DB website.
Next up is a commodity pair, the USDCAD. Since oil is such a big part of Canada's economy, any significant downturns in oil, is bad for the Canadian Dollar.
That is why the USDCAD is on a tear.
It has a ways to go to its high of 1.6185, but once it gets into that neighborhood, a short position is in order. Could it make its way back down to parity?
That is certainly a reasonable profit target. But even a higher profit target can be a great trade…if you can get into, and stay in the trade near historical highs.
The key will be to scale in and have a big stop loss.
A similar trade is the Canadian Dollar against the Japanese Yen. The play here is that Japan imports most of its oil.
In fact, over 80% of Japan's crude oil is imported.
So, low oil prices: great for Japan…terrible for Canada. You get a double whammy with this currency pair.
When the oil rebound finally kicks in, this currency pair should start to head back up. Here is the current chart.
When you look at price action, 76.18 (magenta line) might be a good place to start doing a Trade Up into the position. But even if I'm wrong, if I give myself enough downside room, I can hold on to the position, even if it drops below the 2009 low of 68.37.
Holding a CADJPY position from the mid 70's until about the intermediate high of 97 will take a lot of discipline, but would really pay off.
This option isn't for most people, but if you have the cash to trade futures, then this is one way to take advantage of historically low oil prices. In order to take advantage of the full oil rebound, you would have to roll your long position several times, until it gets back to your target level.
Here is a chart of the current front month.
One thing to note is that futures prices for crude oil are currently in contango, meaning that the spot price is lower than future months. That in itself doesn't mean a whole lot.
However, it is important to keep an eye on this because if it switches to backwardation, then that usually signals higher prices. This is when the spot month is higher than future months, signifying short-term demand.
Futures options are another way that you can get into the market, while limiting your risk. Of course, only if you are buying options or using a hedged strategy. Regardless of how temping it is to sell naked puts below the market, don't do it.
If you read books like Market Wizards or When Super Traders Meet Kryptonite, selling naked options will work great 11 months out of the year. But that 12th month will wipe you out.
But even a simple strategy of buying slightly out of the money call options, and selling puts against them, could be a relatively low risk way of building a long futures position, with limited downside risk.
I'm not an options expert by any means, but I do understand the basics. To read more about options trading strategies, you can read this post by my buddy Gavin.
6. Oil Stocks
If options are too complicated, I don't blame you. I don't trade options either.
You can also trade individual stocks to take advantage of oil rebound prices. But which stocks should you trade?
There are so many possibilities, but to get a good idea of which stocks might be good buys, you really have to dig into the fundamentals of each company.
- What is their breakeven oil price?
- Are they in a position to expand their oil output, when prices start to move up?
- Is their oil source too expensive to mine?
- How correlated is the stock price to oil prices?
Yes, this will take a lot of research. But if that is your thing, you can be rewarded with a huge return.
7. Oil Stocks with Dividends
This is a small subset of stocks, but one type of stock that you can focus on is oil stocks that pay a dividend. According to TheStreet.com, there are three stocks that you should hold long-term, to get the benefit of dividend yields.
One example is Exxon Mobile (XOM). As you can see from all of the “Ds” at the bottom of the chart, the company has paid out dividends for a loooong time.
In fact, it is one of the few companies to increase their dividends every year, for the past 32 consecutive years! So if you are looking for a passive income dividend play, one of these three stocks are the ones you should be looking at.
The current dividend is $0.73 per share. Not too shabby!
A cool feature of TradingView is that you can overlay another chart on top of the current chart. So I've added oil prices (bar chart) over the XOM chart (candlesticks).
An interesting thing to note is that the stock price generally lags oil prices. Therefore, this will probably give you plenty of time to identify a bottom in oil and look for a good place to get into the stock.
Again, keep your trading risk low and scale into the position, and you can collect the dividends while you wait for oil prices to turn around.
So those are the seven ways that you can potentially take advantage of the upcoming oil rebound. The one you choose (if any) will depend on what you are comfortable with and understand.
These opportunities don't come along that often, so be prepared, keep your risk low and give yourself a large margin of error.
The trade could just make your month, year, or decade.
To learn the Bubble Trading Method and take full advantage of this opportunity, get more information here. You can even make money if you go long and oil keeps going down.
Do you think I'm wrong about the oil rebound? How are you going to trade oil? Let me know in the comments below…
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