Weekly Energy Equities Review, Market Outlook and Trading Plan for May 18-22
May 17, 2020 Trading Blog
The week ahead could be the most volatile environment since we hit the bottom back on March 23. I posted on Twitter early last week that the market is setting up for a run at 296-300 and it continues to look like that’s where we are headed. Many will think that this move is bullish, but it’s probably the last thing you want to see if you are a bull. It’s likely an upthrust pattern which is usually the last move in a distribution and leads into a big leg down. I don’t think that leg down will take out the lows, but it could go pretty deep. As you guys know, I’ve been bullish lately and I think the bottom is in, but the bottom is still a process, not a single point. That process continues this week.
So what likely happens this week? The SPY had a great run off the March 23 bottom, but this range that started back on April 20 could be a distribution created by the buyers who stepped in down at that level. They bought a lot of stock down under 240 and could be distributing that stock and booking their profits. It’s starting to look like a classic Wyckoff distribution pattern. The problem here for traders is that sometimes a distribution pattern can be mistaken for a re-accumulation pattern. There are two choices here, either this market is going to distribute and then take a hard leg down OR this is a re-accumulation and these shares are being absorbed by large names for the next leg up. I’ve been bullish, but I think what we are seeing here is a distribution which leads to a move down within a higher timeframe accumulation pattern.
So just imagine this situation, you are a large fund and you bought the lows down around SPY 220-230. You have a huge position and a matching huge profit, on paper, which you want to cash out because you can clearly see that the economy is horrible and things aren’t going to snap back to normal. We’re approaching 100,000 dead, 30 million people out of work and the consumer is scared. You are probably up 25-30% on all your positions. What do you do? You want to sell. That’s the distribution part of this pattern. You can’t dump them all at once or you kill the price, so it has to be done slowly within a range. And after you sell all those longs in that distribution range because you think the economy is bad and the FED is running out of options, what do you want to do? Of course you want to get short. Where do you find the most liquidity to get short at the best price? You find that liquidity in the 296-300 area.
What’s so special about the 296-300 area? I posted to watch the 287 area this week because that’s the fair value area (or point of control) for this distribution range which started back on April 20. It’s basically the middle of the range. We closed almost right on it Friday. The high of this range is roughly 295 and the low is around 279. If your timeline is like mine, the bears are everywhere and they are eager to short this market. Most of them have been building large short positions in this latest range and have put their stops just over the top of the range in that 296-300 area. That’s where the liquidity is. If you wanted a big short position at the very best price, all you have to do is drive price to 296, activate those stops (buy orders) and get short on them at the top of the range. In addition to all the buy orders from the current shorts, there will also be a huge group of bullish traders who will be buying the breakout. If you want to build an even bigger short position, you sell to those breakout traders. Once the shorts have covered and every last breakout trader has bought, then what happens? Straight down we go because there’s absolutely no demand left to support the market. In addition, the larger players will start selling even more to pressure the market to move in their favor.
It sounds like an easy trade, right? But, sometimes when you think you see a distribution forming, what you are really seeing is a re-accumulation. That’s the trick here on this current market range. The key this week will be determining whether this latest range is a distribution or a re-accumulation. Either way, the telling action will be up at 296-300. If we are looking at a re-accumulation, then the market will breakout from 296 and make a strong run. At some point, the sellers will hit, because as I said before, there are still guys holding big paper profits. If we break 296 and run, eventually the market will pullback and test that breakout point. That’s the decision point for this market. If the pullback holds, then that confirms the re-accumulation pattern and off we go on the next leg to new all time highs. If 296 fails, then that confirms the distribution pattern.
There’s definitely a good trade at 296-300 for both sides of the market. There could also be plenty of news to get it up there with the next coronavirus stimulus package of three trillion set to pass this week. The liquidity just keeps on flowing and the market loves it. I’m probably going to be taking the short position when the 296-300 area fails. In the bigger picture, there are three levels that I’m watching on the downside for SPY: 266, 257 and 248. However, if this market looks exceptionally strong and it looks like the pullback to the breakout point is going to hold, then I have no problem trying a long trade with a tight stop. No matter which way the market goes, we are at a big pivot point, so whichever trade you decide to take, you definitely have to hold your stops. The move off this pivot could be very large and you don’t want to get stubborn and pull your stops. Don’t be scared to give it a play, but definitely protect yourself.
Overall Market SPY IWM XLF
I’ve covered larger timeframe for SPY above, but on the lower technical level, I’m watching 287 Monday on the upside. If it gaps up above 287, then I’ll want to put on a long trade if it drifts back to test Friday’s close. On the downside, I’m watching 279 and 276.37. If the SPY fails at 287 and starts down, I’m probably not going to be trading the long side at either of those downside points. A failure to run up to the top of the range near 295 would be a huge sign of weakness and I don’t think last week’s low of 276.37 would hold. If that 276.37 level breaks, that opens up 266.
I still think the IWM is the more important index to watch. It reflects the smaller domestic companies in the United States and it much more closely monitors the consumer. The IWM is in worse shape than SPY. While the 287 point is important for SPY, 125 is the equivalent important spot for IWM. It closed 125.13 on Friday, which was right on the VWAP for the week. If 125 fails on Monday, that opens up huge downside for IWM, probably down to the 114-116 area. If it can gap up open on Monday and drift back down to 125, then I’d be willing to give it a try long there with a tight stop. I’ll be watching 129 and 133 if the week is bullish.
As I wrote in last week’s article, the financials are probably the most important group to watch. They totally failed last week and I read somewhere that they have declined to only 10% of the S&P500 composition. I was looking at trading JPM in the 90-91 area, but it failed and reached a low around 82 on Thursday. If the SPY is going to recover, the financials must make a big reversal this week. Watch the 21.50 point on XLF. If it can get back above that, then this market has as chance.
The GDX keeps moving inversely to the financials. It had a great week closing at 36.57 for about a 5% gain. It still has room to the 40-41 area. If the financials keep moving down, then keep trading GDX to the long side.
Energy XLE XOP XOM CVX WTI
The XLE is working on its own range between 35.25 and 39. The range started back on April 27 and has a fair value of about 37. Price tested 37 on Friday and failed, closing down near 36. Trading the XLE this week will depend a lot on what the SPY does. Much like the SPY, I think there are two trades available this week. The first one is a run to the top of the range around 39 for a reversal and leg down. The other is a breakout of 39, retest of the breakout point from above and subsequent leg up. While the XLE does follow SPY fairly closely, I think the IWM is the one to watch to determine which trade to take in XLE. At this point, I really doubt the XLE is going to be able to take out 39, there just doesn’t seem to be enough demand.
Technically, I’ll be watching the 36.75-37 area on Monday. If it can break that level, it might make a run at the top of the range before running into supply around 38. On the downside, the first level to watch is 35.50 and then last week’s low of 34.30. If last week’s low breaks and the SPY also fails, price could drop to the 31-32 area where I’d really consider starting a longer term position.
XOM and CVX both broke their uptrends this week, with XOM again being the weaker of the two. If you go back to their January highs before the virus event started, CVX has has run right to the 61.8% retracement level of that decline while XOM has only managed to barely clip the 38.2% retracement level. I would imagine there are a lot of long/short pairs out there. I don’t see any event that is going to force anyone out of that trade. I’m watching 86, 82 and 79 on the downside for CVX. For XOM, I’m watching the 39-40 area and 36.
There’s an interesting trade developing in BP at the 21.25 area. If it gaps down this week, I’ll be looking to get long on a reclaim of 21.25 for a run back to 24. The trade can easily be stopped out for less than 50 cents worth of risk and the reward could be $2.50+ for a nice 5:1 return. This is a risky trade because BP and RDSA usually move in tandem and RDSA has already broken this support area, so BP could follow. Always let these reclaim trades confirm before you enter. Do not try to outguess the market with an early entry.
If we do get a big SPY pullback, I’m going to be watching 37.50 and 34.50 in COP. This is the one I’d like to grab in the longer term account. I’ll probably divide the money into four quarters and start a scale in long around 36 and add at 33 and 31. If it breaks 30, I’ll throw the last quarter in on any capitulation move.
I’m also starting to get interested in the service names, specifically SLB. I’m watching for a long trade in the 15-15.25 area this week. If it offers an entry close to 15, then it can probably be stopped at 14.75 with a possible return of 17.75. That’s a huge return of 11:1 and definitely worth a play. If I miss the trade and lose 25 cents at 15, then I’ll probably try the same trade again at 14 for another 25 cent risk. Another service name that’s starting to look like a good trade is HP. The rig count just keeps dropping, but HP has leveled out in the 16-21 range and could be worth a look on the long side if it dips into the 15 area. There’s a nice consolidation going on and if price dips out of the bottom of that consolidation for a nice spring pattern, it would definitely be worth a try.
I was just starting to get excited about the natural gas names again, but they seem to be starting another leg down. COG dropped about 11% this week and EQT lost about 8%. RRC and AR were even bigger losers, both dropping about 20%. This group was the main reason XOP dropped about 11% this week while the XLE was only down about 7%. I discussed last week about maybe getting involved again with XOP, but after seeing the action in the natural gas names this week, that plan is probably off the table. I’ll move XOP to the back burner for awhile longer.
The refiners were another group that really disappointed last week. I had some long trades scoped out, but never got an entry on any of them as the group just collapsed. VLO lost about 11% for the week and MPC wasn’t much better losing about 8%. HFC is a name that might be worth a look for a quick trade. There’s good demand in the 25-25.50 area and it could probably be stopped with 50 cents. The trade also sets up nicely in the 22-23 area if the downward momentum is high this week. I’m watching 52-53 in VLO and 28-29 in MPC.
Trading Plan for the Week – I think we get a move up this week. I’m playing everything off of SPY 287. If price gets above 287, I’ll be playing on the long side for all my trades. If SPY drops below 287 and stalls out, then I’ll probably head to the sidelines to see how it looks around 279. I’m not comfortable shorting anything while SPY is in this 279-287 range. If things go as I expect, SPY should easily take out 287 and then make a run at the 296-300 area where I’ll definitely be interested in getting short.
For the XLE, 37 is the area to watch. If price takes that level out, I’ll be looking to trade the long side in energy. Last week’s VWAP is 36.95, the eight day moving average is 37.05 and Friday’s high is 36.89. And we still have that long standing 36-37 range in play, so there is a lot of confluence around 37. My plan here really depends on where we open Monday. If we gap down, I’ll probably get interested in a long play near Friday’s low of 34.30 with a fairly tight stop. If we gap up, I’ll watch 37 and if price can take that out I’ll try to get long and use all that confluence around 37 as my stop. If the SPY runs toward the highs as I expect, then XLE should also make a run at the highs around 39. I can probably get a 50 cent stop around 36.50 and a possible gain of $2.00 on the run to 39, for something around 3:1 on the trade.
The MGM position I took last week is looking pretty good so far. I managed to get about 3/4 of the money in with an average price of 13.13. It closed at 13.85 on Friday, so at least it’s green. I had planned on putting in the last quarter of the position under 11, but MGM bottomed out at 11.77. I’m not sure that this one is out of the woods yet, so I’ll hold that last quarter to see if it can pull back one more time to get the rest of the money in. I’m watching PENN this week for an entry in the 16 area. This stock is extremely strong. There was a secondary offering of about 16 million shares at 18, which was about 15% of the existing float, and the market soaked it up no problem. I’d love another chance at this one in the 14-16 range, but it would probably take a big SPY correction to pull it down that far. It’s possible though.
If the financials manage to reverse and start upward there could be two trades available on this move. First, I’m watching JPM for another drop into the 83-84 area for a long attempt. I’d look to get it as close to 83 as possible and set the stop at 82 with a profit target of 90. The second trade is a GDX short. If the financials recover, then gold could take a dip, especially if the SPY does truly breakout from 296. My whole trading plan has been based on a reversal up at 296, but if I’m wrong and this market does breakout and head for new highs, the financials will follow and GDX should pullback hard. There’s a fairly defined spot around 37 to give the short trade a try, but it might require finding some intraday structure which will develop this week. You could also put the same short trade on in NEM around 68-69.
On a personal note, I got my coronavirus antibody test back and it was negative, wife’s was the same. Between the two of us, we traveled to Las Vegas for a week, Chicago, Dallas, Charlotte, Phoenix and Washington DC and somehow never came in contact with the virus. That’s a lot of germ contact, so it kind of makes me wonder how widespread this really is and how contagious it really is. We will probably never get the true facts. If you want to get tested, here’s the writeup on the procedure we went through, it’s really quick and easy and worth the money to know if you have previously been exposed.
Good luck this week. It’s going to be a week where being nimble is very important. Be flexible and most importantly use stops and hold to your risk management. The move off this pivot could be huge, so protect yourself. If the week is really busy, I’ll probably be off Twitter during regular market hours.