Oil Speculators Wrongly Are at It Again

 | Aug 01, 2017 | 1:30 PM EDT
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This commentary originally appeared on Real Money Pro at 11:30 on Aug.1. Click here to learn about this dynamic market information service for active traders.

The strategy of trend trading is one where traders aren't concerned with having a high win/loss ratio. Instead, they swing for the fence in hopes of hitting an occasional home run without regard to the frequency of strikeouts. In the game of trend trading, it is possible for one large market move to dwarf multiple moderate losses. However, in crude oil futures, the stakes are high and trend traders are experiencing an overwhelming test of their conviction.

We can see it in the charts and the Commitments of Traders (COT) data offered by the Commodity Futures Trading Commission -- trend traders are jumping on the oil bandwagon at precisely the wrong time. Specifically, long speculators are piling into bullish trades near the peak of oil prices and liquidating the majority of their bullish holdings on the troughs. Obviously, the goal is to buy low and sell high, but this group simply has been on the wrong foot all year. We suspect we are in the midst of a repeat of this phenomenon. Nobody wanted to be long oil when it was in the low $40s, but now that we are in the low $50s the masses are scrambling to buy. Unfortunately for them, they are probably late to the party (again).

According to the latest COT Report, as of Tuesday of last week large speculators (those with deep pockets and trading large futures positions) had amassed a net long position of roughly 420,000. We've seen this figure as high as 525,000 just before prices peaked near $55 per barrel earlier this year. Given that oil has moved higher since the Tuesday measurement date, we suspect that large speculators are holding a net long position in the ballpark of 450,000 to 475,000. Accordingly, most of the oil rally likely has occurred already. It would take a considerably bullish shift in fundamentals to move prices above resistance areas in the mid to low $50s because speculative firepower is running low.

Source: QST, Barchart.com

Last month, we were looking for the price of oil to recover to somewhere between $49 and $51 per barrel. The high of this move has been about $50.40, which meets our objective and appears to have completed, or is near completing, the technical pattern. In essence, any easy money on the upside has been made. Being long oil from these levels will be a challenge and, more importantly, could be an expensive lesson.

Technical oscillators are suggesting the rally is becoming overheated; the relative strength index (RSI) is above 70, which is somewhat rare and generally triggers some profit taking. Also, we see swift resistance near $50.50 and again near $52.50. The odds favor a reversal at some point in this range. If we are wrong, a full retest of $55 isn't out of the question, but it isn't likely, and if seen would be considered a high probability area from which to be bearish.

Oil has posted impressive gains in recent weeks, but we've yet to see any signs that this trend will surpass resistance areas. Further, we saw similarly sharp oil rallies earlier in 2017 that eventually were met with swift selling. Until there is a fundamental change, the cycle likely will persist. Thus, in our view, the opportunity to be long oil has passed. The better trades likely will be those with a bearish outlook in the coming weeks or months.

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