Why is oil so crude?

Did you notice cheaper gas prices at the pump? That's pretty neat!

I'm going to explain why this is all happening. Actually no I'm not, because I don't know what's happening. There's rumors about a Saudi price war and that's all I have to really go off of.

See the thing is, trading is not about keeping up to date with current events. We're more concerned with the why. Allow me to elaborate. See this?

 

That is a chart of crude oil futures, and each bar represents one month. You can see that lately crude oil prices have basically jumped off a cliff. Hooray for the consumers! That's bad for oil traders right?

Wrong! Here's something that a suprisng amount of people don't know. In fact, it's something that blew my mind when I first learned about it. You can make money when a stock, future, or whatever goes down. At some point you may hear the term "shorting", or "I am short oil". That's what the term is referring to.

 On this chart I have a couple of indicators. The arrow is pointing to something called the squeeze which measures how much energy the underlying asset has built up (or you could say volatility contraction if you wanted to sound fancy). When there's red dots, it's going to make a big move one way or the other. You can see that this month, the red dots turned green. We have to wait until the end of the month to be sure, but we're potentially seeing a "squeeze" firing short. If this is the case, we will continue to see lower prices in oil, and therefore, gasoline, for the next 6 to 8 months.

Hooray! How to trade this? Well, let's look at a shorter term time frame. Introducing the daily chart:

  There's different ways to "short" oil. But you don't want to even consider getting short oil until it has either reached the yellow or the purple line (exponentional moving averages, or something).

Anyhoo, you can pick how aggressive you would like to be, depending on your goals and personality. The conservate way to trade would be to only get in - and I mean ONLY GET IN - when it has reached the purple line. At that point you could sell a "credit spread". You would position this spread thing above the purple line. Now all that has to happen is the stock has trade either: slightly higher, sideways, or down and you make money. It's only about 10 to 15 percent return but you'll live.

If it doesn't do either of these things, well that's when you have to react with steel nerves and make decisions based on your predetermined plan and not your emotion - that's what separates the pros from the not-pros.

 If you wanted to be very aggressive, you could wait until it only reaches the yellow line, and then but a "put" which goes up in value when the underlying asset goes down. In this case, it HAS to trade in the correct direction. Even if just sits there, it will lose value. That's our little friend, time (theta) decay. But you could also make something like a 100% return.

 You can construct trades between those two extremes, and there are many, many ways to put together a trade.

 And there you have it. That wasn't so painful.