Weekly Energy Equities Review, Market Outlook and Trading Plan for 22-26
Feb 21, 2021 Trading Blog
This is a difficult market. I went back to 100% cash on Thursday and have no real desire to jump back into anything this week at these levels. I had a great short position in IWM from around 227.75, and I really thought it might pull back toward the 215 level, possibly even 205, but it ran into a wall of demand Thursday around 220 causing me to cover, which was good because it ripped right back to 225 Friday. I posted an interesting chart on Friday showing that there may indeed be another leg up coming in IWM, possibly to the 245-250 area. I doubt I’ll be riding that long, but I have no problem sitting back and waiting for the short play if this is a blowoff top.
The only thing I can really say about this market is that correct risk-controlled trading gets more and more difficult as the market disconnects from reality and the bubble grows. Sometimes you just have to exit the game for awhile and just watch the action because the odds on one side just don’t offer anything with a long term positive expectation. Trading on the long side is getting VERY expensive. It’s a bit frustrating to slow down when the masses are pedal to the metal long and making money, but I’ve also been doing this long enough to know those guys will stay at the party too long and lose everything, and then some. I know, because I’ve done it before. We think of a market disconnecting from reality, but the truth is the market is nothing more than individual traders, you and me. The market is not some external entity, it is made of us, and many are trading on the edge of disaster in a market that they think will never go down. The “market” isn’t disconnecting from reality, we are. It’s time to tighten things up. Size down, tighten stops, be more selective in your setups and realize that things can change on a dime. Survival above all else.
SPY – It was a bit of a negative week for SPY. It opened at new all time highs around 394 on Tuesday morning, but then just drifted down all week closing at 390. The week’s VWAP was 391.15. It really didn’t give any clues for what to expect this week, but the important points to watch are 393-394 area on the upside and 387-388 on the downside. Given what this market has done for the last three months, you have to assume that the bull keeps running. I won’t be getting long, but it’s also a very difficult place to get short. I need to see some real euphoria and another price spike before I attempt another short play.
QQQ – Tech was much the same story as the SPY, but the QQQ remains in an uptrend. I’m watching the 338-339 level on the upside and the 326-328 level on the downside. The interesting watch in tech is AAPL. It’s getting dangerously close to breaking its uptrend, so keep an eye on 127. A breakdown in AAPL would probably put in a top for MSFT and then trickle into the other FAANGs, especially FB, GOOGL and AMZN, all of which have been consolidating for months trying to decide which direction to go. If AAPL and MSFT turn down, then FB, GOOGL and AMZN could decide to break to the downside out of their consolidations, at which point the lesser techs could follow. As rates climb, keep an eye on tech.
IWM – Small caps are still my favorite short target and last week showed the potential for profit on the short side. IWM opened the week around 230 and gave up 10 points in three days. You have to be nimble to catch the moves, but the big move is coming soon and that’s the wave I’m looking to ride. I think there’s probably another move up coming in IWM, especially if the action I described above evolves in the QQQ, and if rates keep rising. There has been a rotation from big tech to small caps going on for months and that could accelerate if tech makes a move down. The rotation has been primarily from tech into banks and energy, so keep an eye on that QQQ/IWM correlation for clues on energy, as well as the TLT/XLF for clues of money rotating into banks. If IWM and KRE keep going up, that’s a good signal that XOP/XLE will follow.
TLT – Bonds are trapped in a brutal selloff, which is causing rates to rise faster than the FED wants. The real issue for equity traders is where do rates top out, or alternatively where does TLT find a bottom? At some point, rates will reach a point that spooks the equity market. On the other hand, there’s probably a point where rising rates will cause the FED to step in and blow even more air into the bubble. I don’t know where either of those points are, but if we start having more days where bonds and stocks are both red, that’s a signal you must pay attention to. I have way more experience with stocks than I do with bonds, but if I had to guess, the TLT should bottom in the next couple weeks. The low point on the pandemic panic back in March was around 138, while the TLT closed around 143 on Friday. I’d say 136-138 would be a good spot to possibly setup a long play for a bounce.
GLD/GDX – TLT is also offering a big clue for gold. I posted a GDX trade last week, but I’m starting to get a little concerned about that setup. Both GLD and TLT have been moving together since August. For GDX, I am watching the 30-31 level, which was the breakout point from the Aug 2019-Feb 2020 base. The problem is that the TLT also made that same base formation, however TLT has broken below that level, will GDX follow and also break below that level? There’s a big level for GLD coming up this week. If TLT continues to fall, it will be difficult for GLD to hold the 165-166 level. If that level breaks in GLD, there’s easily 10 points of room to 156-158. That should be enough to knock GDX down to a possible entry location. The only worry I have with this trade is that the GDX gets into a spiral down toward the 25 level. Definitely have to be patient with the entry and scale it rather than plunging in with one move. I’ll post the entry on the GDX trade on Twitter if it arrives.
UUP/CAD – The dollar is still the big question mark in the macro picture. I wrote last week that there’s a level at 24.27 that the bulls must defend. It dropped to 24.33 and closed at 24.36 on Friday, so I’m thinking that demand level gets tested early this week. If that level holds and the dollar finally does turn upward, that’s going to knock gold down for a great entry into GDX. The only question is how fast is the rise in the dollar? I mentioned a downward spiral in GDX being possible, and that’s just what could happen if the dollar rises faster than traders expect. On the other hand, if 24.27 breaks this week and the dollar collapses, GLD and GDX should move back to the upside and that trade is probably gone. As for the CAD, it took out an important level Friday. It just keeps strengthening, which is a good thing for oil. Watch the 1.2600 level and then the 1.2700 level for clues on the dollar/oil correlation. If the CAD takes out 1.2600 and strengthens quickly, oil could keep moving up.
Most traders have just written the dollar off and they expect it to continue to collapse, but I think that’s wrong. As commodities rise, rates will continue to rise. If rates continue to rise, yields in the US currency will become more attractive in the Forex market and money will eventually flow into the dollar to take advantage of those higher yields. I think the dollar is getting stretched to the downside and the snapback could be quick, which could be damaging to commodity stocks including GDX and XLE. Watch the dollar this week, and if it looks like a bounce, then it could be a good move to lighten up on some of the commodity stocks.
XLF – As the TLT keeps dropping, financials keep rising. The XLF is now well above the 31.55-31.62 breakout area and it doesn’t look like there’s going to be an immediate re-test of that breakout area. Financials are in a blue sky area now and who knows how far the market will take them. I think there’s a really good chance that the XLF chart could end up looking very much like the current IWM chart. If you are long energy, then this XLF action is very positive since both sectors have been running together on the rotation out of tech into banks/energy. Watch the TLT/XLF correlation for clues on the energy sector.
Energy XLE/XOP – The XLE is trapped in the 45-46 area right now, which isn’t a bad thing. Price stayed in a one dollar range for the entire week, which is a little unusual for energy. There’s a huge supply level in that area which extends back to the March OPEC meeting disaster at 46 and the mid-June highs around 47. The buyers are chewing into that supply. The real question is how much supply is actually there? Do we run out of buyers before all the supply is cleared, therefore leading to a big pullback? Or do the buyers actually chew up all the supply and break through that level and make a move at the next supply level up at 54? I’m really not sure how much supply is there, but I think it’s fairly large. If the overall market keeps rising, then the buyers will keep chipping away at that supply level. However, if the SPY finally gets a pullback, the demand for XLE might step back and the remaining supply could get aggressive and start moving down on the chart, thereby producing pullback toward the 40-41 area.
I’m still bearish on energy. I think people who read my Twitter or blog think I absolutely hate energy, but that’s not true, I just don’t like the current trading position of energy. It’s just in an area where a long trade just isn’t worth the risk, and it’s been in that area since early December. If it moves to a better area, then my bias changes. The max return on the trade is still that 54 area (8 points), while the downside could easily be 37-38 (8+ points). The odds on either side are probably 50/50, so the trade just doesn’t have much expectation to offer right now. The better move is to let XLE pull back toward the 41 level and then take the long trade. In that situation there’s 13-14 points of potential profit with about 5 points of risk, while the odds of the trade working are still around that same 50/50. The long trade at 46 offers no long term positive expectation, however the long at 40 is nearly 3:1 and a huge positive expectation. If it did pull back that far, I’d likely move to being a bit more bullish and might even take a shot long in that area. Most times trading isn’t about being right or wrong, it’s more about what you win when right versus what you lose when wrong. While I am bearish on XLE right now, that doesn’t necessarily mean I hate energy, it simply means that the I don’t like the long side of energy given these odds and payouts.
As for the technicals for energy, I posted an XLE chart last week showing an upsloping channel which started back in the first week of December. Price has moved just above the upper channel and also right into that thick supply area of 46-48 which goes back almost a year. XLE is right in a very likely pullback spot right now, yet it hasn’t dropped at all. There’s demand at this level, but again, there’s also huge supply blocking the way up. I’m watching 48 on the upside for clues this week. If it can break through this wall at 46-48, there’s no reason that it can’t make a quick rip toward the low 50’s, at which point I’ll probably move to the short side. If price rejects in this 46-48 area, then the supply probably starts getting more aggressive and 40 becomes the downside point of information. If price reaches the 38-40 area I’ll probably move to the long side. Again, my bias isn’t so much on the energy sector and its fundamentals, it’s much more based on trade locations, odds of success and risk/reward offered.
For Monday in XLE, it’s all about the top of last week’s range around 46.50 and the bottom of the range around 45.50. Last week’s VWAP was almost perfect center at 45.95. One thing I would point out though, if you are a breakout trader, be really careful here. This thing is setup to where it’s going to give you a false signal on the first break. If it gaps up or breaks to the upside Monday, I’d be really cautious chasing that. Same story on any downside gap or break, it’s likely a stop hunt for a run to the upside. If I see the downside stop hunt, I very well might put on an intraday long trade in XLE. If you are trading XOP, the basic theme is the same, but just a little more tricky. There’s a heavy fair value area around 77.25, with the downside being 75.50 and the upside being 79. The XLE setup is a much easier trade, however the XOP trade probably offers more reward to the upside.
Trading Plan for the Week – On Monday I’m considering an intraday long trade in XLE. I’ll be watching for any gap down or breakdown early in XLE. If I see it and think it’s a stop hunt, I’ll put on a reclaim trade as price re-enters last week’s (or Friday’s) low, with the stop being placed a safe level below the Monday morning low point. On this trade setup, you MUST let price get sufficiently back within last week’s price range or there’s no trade. Don’t anticipate or guess or try to front run the trade, just let it develop and then enter. That’s really the only daytrade I have on the radar for Monday.
On a bit of a longer term (for me anyway) I’m watching a possible GDX long trade as price breaks under 32. I’ll be looking to scale into the trade in probably four pieces. This one will require some patience, as the GDX could spiral down quickly if the dollar and TLT move sharply. The key is to wait a long as possible for the first piece entry. Once in, I’m looking for the trade to move back up toward 36-38 for a 20% gainer. I expect there is some FED action coming if rates continue to climb, which could help gold.
On the same timeframe as GDX, I’m also watching XLE for a long play in the 40-41 area. This is another trade that could spike down quickly, so scale entering in a few pieces is probably the way to go. A scale started at 40 could probably go with four pieces down to 35. The reward on that trade could be >25% if the XLE does eventually take a shot at that 54 level. Worst case is an entry around 40 with another (fourth) shot at the 46-48 level, for a 15-20% gainer. I really can’t see energy going much lower than 35, unless the overall market gets really ugly, in which case I’d be cautious to enter anyway.
I’m watching the move up in IWM for another short play. I think the euphoria in this market is most evident in small caps. I’ll be watching 230 this week for clues. I might try a smallish short trade at 230 depending on the speed of upward movement, but what I’d really like to see is a breakout of 230 and a very quick move to 240-245 for a really big short position. The IWM short will require some patience and it’s definitely a trade where the entry is a scale in with probably four pieces.
I’ve got TLT on the radar for a possible long play this week, but I’m not sure where that trade location is. Bonds are extended and eventually the FED is going to step in. I’ll be watching this week for any tradable setup to the long side, especially on any selling climax early in the week.
KRE is also on the radar for a short play, but with the TLT/XLF correlation, I’d probably be better off playing the TLT long rather than trying to play the KRE short. Even if bonds find a bottom, financials could continue upward. However, the KRE is running into some supply at the 65 level and given the speed of this move up, there could be a pullback coming there. A short on a rejection of 65-66 could be a play this week.
Those five trades are really all I’ve got on the watchlist for this week. I’m still avoiding individual stocks right now, as all of my possible plays are larger market, macro type plays. It’s really frustrating to be right on the macro picture and then play an individual stock that simply ignores the larger picture and does something totally unexpected. There’s a good chance this market continues to grind up this week, but like I said, the long side is becoming really expensive. It’s kind of like betting on the heavily favored home team in sports, at some point the odds just get too high and don’t represent the skill of the team, it’s all geared to take advantage of the home team fan/bettors. And that’s when the upset is just around the corner and the correct play is to go against the home team. Good luck this week.