• 
• 
• 

• Performance
• Services
• Company
• Learn About
• My Attain

The time for Swing Trading Crude Oil is Now!

August 29, 2005

 

With Hurricane Katrina barreling down on New Orleans and SE Louisiana last night — where approximately 25% of the United States' Oil refining, importing, and production capacity is located, Crude Oil was up 7% at one point last night — hitting $70.80 per barrel.

That's up over 40% on the year, and Unleaded Gas prices were shooting up even higher - rising over 20 cents in overnight trading, while Natural Gas was up over 20% at one point in overnight trading. Prices returned to normal a little bit by this afternoon, but unlike the price spikes on demand we have seen over much of the past two years - this is a supply side spike. There are 4 major refineries in Southeast Louisiana and countless Oil and Natural Gas production rigs in Gulf - so the hurricane is disrupting not just production, but also refining.

The true test will come in the next few days, as every day power is down and workers can't get refineries back on line — millions of barrels of oil are taken out of supply — as Oil will not be produced (pumped up on offshore rigs) and Oil won't be refined (turned into gasoline, diesel, heating oil, etc.). News came out that the government may tap their 700 million barrel strategic reserve, but that is a band aid — as eventually the government will have to replenish that supply — meaning artificial demand and likely higher prices because of it.

With all of this volatility in the Crude Oil market, the obvious question many sophisticated investors have is what and how is the best way to trade this market - how can you get exposure?

Well, there are a few ways to get exposure to the energy markets. Investors can buy (or sell short) the stock of publicly traded companies that explore, drill for, produce, refine, or sell oil. This includes energy stocks like Exxon Mobil or Valero Energy.

A second option is a commodity fund which has an energy component. This is a long only investment however, and you get a lot more than just Crude Oil, with other energy markets and other commodity markets, like Cotton or Copper included.

The next option is investing in Crude Oil futures themselves. Crude Oil futures are traded on the New York Mercantile Exchange, with the contract worth 1,000 barrels of oil. So, buying one contract of Crude Oil, an investor would make $1,000 for every $1 the price rises. ($1 * $1,000 barrels = $1,000). The margin balance needed in an account to initiate a Crude Oil position is just shy of $5,000. But simply buying or selling Crude Oil futures is fraught with risk. Where do you buy? How much do you risk? When do you get out? You need a plan, and that is exactly what a trading system gives you.

System Trading Crude Oil

The final option and one we're most qualified to talk about - is system trading Crude Oil futures.

The traditional method of system trading Crude Oil futures was with a long term, trend following system like Aberration or Synergy. Trend followers are designed to capture trends, and we would expect them to do well in a market which has nearly doubled in the past two years. But when testing how several trend followers have performed over the past few years (see table below), some alarming stats appear. More than half of the trend followers didn't make money during the recent uptrend. How could this be?

The main reason many trend followers have not done well in Crude Oil during the recent uptrend is that it has been too long - a sort of super-trend. The price of Crude has sold off down below its 100 day moving average 8 separate times in the past 24 months. The different trend following systems use different models to signal the end of a trend, but nearly all of them will get an exit signal when the prices come all the way back down to the 100 day Moving Average.

So Crude is going just high enough to signal a lot of trend followers long, but then it is having some sharp reversals to the downside during the uptrend which are stopping the systems out. This type of action is resulting in above average volatility in the Crude Oil market, and for that distinct reason, many trend followers try and filter out trades in markets with a tendency for this type of price action. The following table shows the same trend following systems as above, but with each utilizing risk filters where the system will not issue a trade if the risk is above a certain dollar amount. You can see that each of the losing systems from above filtered out all of those trades - as they were too risky.

So, while many investors utilize a trend following system for the exact reason of getting exposure to markets like Crude Oil, the grand majority of investors don't even have that exposure because the risk is too high for the average investor. With trend following either struggling or not trading the energy markets at all - it begs the question: Can you day trade, or swing trade, Crude Oil?

Can you Day Trade or Swing Trade Crude Oil?

Whetehr you can profitably day and swing trade Crude Oil comes down to the question of what is a realistic slippage number. Up until recently - a realistic slippage number in Crude Oil might have been as high as $500 per R/T, or 25 cents a side (at a 10 yr average price of roughly $30, that's over 1.66% of the price) compare that with slippage of just .50 cents ($125) in S&P futures, which is just ½ of 1% of the index price - and you can quickly see why the S&P market is the preferred market for day and swing traders.

But with the huge uptrend the past few years has come more volume and better liquidity in Crude Oil futures, leading to slippage numbers as low as .05 per side, or $100 per trade. At an average price of around $45 over the past two years, $100 in slippage is just 2/10 of 1% of the price and much closer to the acceptable slippage numbers in the S&P futures

Additionally, NYMEX introduced the mini CL, and it is changing the game - much like the emini SP did for day and swing trading stock index futures. Unlike the e-mini stock index futures, mini Crude contracts are 1/2 the value of their full size brethren, or $5 per tick, and $500 per full $1 move in the price of a barrel of Crude. The mini Crude has made successfully day and swing trading Crude Oil even more of a reality. In a special actual trading test done for Attain Capital using the mini Crude, we measured slippage of just 1.5 ticks per side in an actual trading. That brings electronic Crude slippage to just 6/100 of 1% of the price - which is very doable.

To put these theories to the test, we ran several swing trading systems on Crude Oil data over the past two years to see how they would do. The numbers were very encouraging, with all three systems we tested doing quite well. Given that these three are mainly swing systems designed for other markets, it is very encouraging that they are robust enough to work on CL, but it also hints at the possibility that the market (not the system) is to thank.

The conclusion at Attain Capital is that the time is now for day and swing trading CL, and to a lesser extent NG. This is like the day trading heyday of the Nasdaq and SP in 1999/2000 as we flirt with all time highs and regularly see 2% - 3% and greater daily moves.

It seems we can no longer wait around and complain while SP and Nasdaq volatility continue to dry up, when there is such tradable volatility elsewhere. Whether this tradable volatility can be translated into profits by these and other swing trading systems remains to be seen - but they sure have tested well over the past two years and it sure seems like Crude Oil will remain volatile for the foreseeable future.

The world has changed in regards to Crude Oil, for better or worse, its not our place to say - but we have definitely entered an era where we may see Crude Oil hit $100 per barrel and it may not be unusual to see $3 to $4 gas at the pump. Either way, whether we get to the $100 CL level predicted by Goldman Sachs, or plummet back down to the $25 per barrel average price over the past few decades, there is sure to be a lot of volatility and a lot of big moves in the days, months, and years ahead. These moves will make headlines, and perhaps scare your average investor and some lawmakers, but they are moves that system traders look for and can hopefully profit from.

Attain is recommending to all of its clients that they get exposure to the energy sector through a swing or trend following system ASAP. As for day trading Crude Oil, we haven't found any good day trading CL systems yet - but are assisting several of the developers we work with in researching and testing day trading systems for the CL. As always…..stay tuned.

- Jeff Malec