Mean Reversion Trade In Energy Futures

Given the mean reversion we’ve seen in the grains over the past few weeks, I think that based on the current conditions in energy we could see something similar occur as we head into next year. There are two very important factors in this space that apply to Crude, Gasoline and Heating Oil. I’ll outline those below and then go through the setups individually.

1. There is extreme bearish sentiment in the energy space at this point in time.

Crude oil sentiment is testing roughly 2 year lows and hedgers are slowly unwinding their positions.

Gasoline sentiment is at 12 year lows with the amount of commercial hedging testing last years lows.

Heating oil sentiment is at 12 year lows with the amount of commercial hedging testing lows not seen since last year and before that, 2005.

2. Prices are so far extended from their 200 period moving averages in all of these commodities. I’ll outline them individually, but to provide some perspective, Gasoline futures are currently 33% below their 200 week simple moving average. This is something that, in my opinion, is not sustainable over the long term.

Now that we have some perspective on sentiment and the possibility of mean reversion, let’s see what price is telling us.

From a structural perspective, Crude oil is a mess after it broke down from a 4 year symmetrical triangle and is reaching the most oversold it’s been since ’09. Given where sentiment is, we can’t be short and are leaning more neutral/bullish.

1. Prices 23% below a falling 200 week.

2. Prices finding support at 3 year support level near 76.

3. Long wick on the weekly candle (needs follow through).

Crude Weekly
Despite the neutral stance represented on the higher timeframe, I think from a tactical perspective Crude is setting up nicely on the long side.

1. Prices 19% below a falling 200 day.

2. Prices consolidating above the 161.8% extension of the prior consolidation.

3. Positive momentum divergence as price made new lows.

4. 10/15 pivot low to trade against if we get back above.

Crude Daily

Given the amount of bearish sentiment and the setup we are seeing on the daily as we bounce off weekly support, I think that we could get a nice move on the long side in Crude. The way to play this is buying a close above the 10/15 pivot low of 79.10 and putting a stop back below those lows. This will confirm both the positive momentum divergence and the false breakdown in price. This will target a move towards 84 initially and then 88 if we get above that. With sentiment, price, momentum and mean reversion all involved in this setup, I think the risk/reward is really good here. If we do get a close back below that 79.10 pivot low then we know we’re wrong and move on.

Gasoline has been a mess from a structural perspective since it broke multi-year support in September. We have reached our target of the 161.8% fibonacci extension of the November ’13 – June ’14 rally and are now the most oversold since early ’09. Given where sentiment is at, our target being met and price being this far extended from the 200 week we can’t be short, so a more neutral stance is appropriate here.

1. Prices 33% below the 200 week.

2. Momentum most oversold since ’08.

3. Bullish wick at the 161.8% extension of the November ’13 – June ’14 rally.

Gasoline Weekly

Despite the neutral bias on the weekly timeframe, I think that the daily setup in gasoline is really interesting on the long side.

1. Prices 16% below the 200 day.

2. False breakdown confirmed with a move back above the 161.8% extension outlined on the weekly chart.

3. Positive momentum divergence.

Gasoline Daily

Given the false breakdown in price, mean reversion possibility, extreme bearish sentiment and positive momentum divergence on the daily I think that Gasoline is headed higher. To define my risk I’d be long against 2.0880, which represents the October lows that prices broke back above late in the week. The first target I’d be looking at is the 2 year support level at 2.28 where I’d re-evaluate the position. 

Structurally Heating Oil is a mess like Crude and Gasoline, but given that we’ve reached our target at the 161.8% fibonacci extension of the April-August 2013 rally and that we’ve been basing for four weeks, a neutral/bullish stance is best here.

1. Prices 19% below the 200 week.

2. Prices basing above the 161.8% fibonacci extension of the April-August 2013 rally.

3. Positive momentum divergence forming at the most oversold levels since ’09.

4. Prices trying to retake the 2011 lows.

Heating Oil Weekly

Now that we know we have a neutral/bullish bias on the higher timeframe, lets see if the daily timeframe confirms this bias. Based on where sentiment is at, I think that we could really see a move in Heating Oil based on the daily price action.

1. Prices 14% below the 200 day.

2. Prices basing above the 161.8% fibonacci extension of the April-August 2013 rally.

3. Large positive momentum divergence.

4. Relative strength (Heating Oil did not make new lows the past few weeks with Crude and Gasoline).

5. Clear pivots to trade against.

Heating Oil Daily

Given the bullish developments on both the weekly and daily timeframes, I think that Heating Oil is the best play in the energy space if you’re looking for mean reversion. We have positive momentum divergences on both timeframes, sentiment is at 12 year lows, hedgers that aren’t hedging, mean reversion toward the 200 period moving averages and relative strength suggesting that we go higher. You could stay long above the October lows, but given how picky I am on entries I may be so inclined to buy a break above the 2.5428 pviot high and put a stop back below the 2011 lows of 2.51. This breakout would target a move up toward broken support at 2.7250 or so, with some stops along the way.

That’s what I’m seeing in the energy space. Feel free to share your thoughts with me on twitter or stocktwits @brunicharting.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s