How Do You Get There From Here?

One our readers in the comment section of the blog suggested that I had a nice "call" on oil. Compliments are always great, but in the markets, sometimes, I think it is better to be lucky than good. No matter how much we back test or think we have an edge, the next hand could be a losing one. To make that good "call", a lot of effort has gone into understanding what works and what doesn't, and this is what I try to convey in my writing. However, I still cannot help myself and think that some degree of luck was involved. I guess it is the nature of this trader's mind to remain grounded.

But let's get real for a second and suggest that I have only made half a "call". I have said nothing about when to sell. We all know that tomorrow morning we could wake up and find crude oil down 10%. And then my good "call" becomes a bad "call".

One thing I learned early on in the stock market analysis game was that a "call" should have 4 components to it: 1) the entry; 2) the exit; 3) how much draw down one should tolerate to achieve their goal; and 4) how long it may take to achieve that goal. After doing this in a very public way for over 5 years, I am still amazed at how few analysts and pundits include these factors in their market "calls". I am even guilty of this at times.

People who write about the markets can do better. Period. Oddly, our readers don't demand they do so.

What piques my interest are markets or assets that have the potential for a significant, sustainable rally. These are the kinds of rallies that last months and generally have the secular winds at their backs. (As a side note and for another discussion at some other time, it seems that these kind of price moves are compressed into shorter and shorter time frames.) I have found that strategies -such as day trading or swing trading - that require me to thread the needle (i.e., buy exactly at the open or on the close) are difficult to execute.

I am always asking myself "how do I get there from here?". If I can find an asset or market that has those secular winds and isn't too loved by the investing masses, then all the better. These are the things that go into making a good "call". This is the way to make money.

Let's take the current equity rally. It has come an awful long way in a short time period, and there are a lot of folks invested at this point. This is not my cup of tea, and I am involved in a limited way. On the other hand, crude oil has been consolidating its gains for 4 months; it appears to have those technical, secular tailwinds that I favor; and it isn't loved by investors as sentiment towards crude oil is moderately bearish.

So I ask: How will I get there from here? What is the best way for me to make money at this point? Which hand do I want to play? Crude oil over US equities of course. It may not turn out to be right this time, but over time, it should. If I stay true to my style, things should work out.

This is a bit of a long way for me to get to two contrasting charts. Figure 1 is a daily chart of the S&P Depository Receipts (symbol: SPY). Figure 2 is a daily chart of the United States Oil Fund (symbol: USO). Volume is in the middle panel and the on balance volume indicator (with a 40 day moving average) is in the lower panel.

Figure 1. SPY/ daily

Figure 2. USO/ daily

Now this is just good old fashioned technical analysis. Looking at the SPY chart, the first thing to notice is all the red volume bars (in the middle panel) over the past month. Clearly, the volume on down days is much more significant then the volume on up days. The on balance volume indicator is below its 40 day moving average while price is probing new highs. This is distribution.

In contrast, the USO shows increasing or above average volume on up days. The on balance volume indicator is making new highs along with price. This is solid accumulation.

So once again I ask: how do we get there from here? Looking at these charts, I think USO has a greater probability of doing that for me than SPY.

Lastly, figure 3 is a weekly chart of the USO. The move from the low in February, 2009 to the high in June measures approximately 17 USO points. Adding this to the low of the current base at 31 gives a measured move of 48. Therefore, from a good old fashion TA perspective, USO has a chance of trading to $48.

Figure 3. USO/ weekly

Ok, I will take $50. This is a good round number that I like. This would make a very good "call" indeed.