Trading Choppy Markets Like Crude Oil With Limited Risk

Trading Choppy Markets Like Crude Oil With Limited Risk

Whether you look at the daily, hourly, or 5-minute chart of Crude Oil futures, the pattern looks the same: choppy, sideways price action with occasional sudden moves up or down to another price level and another sideways channel. How do you pick tops and bottoms in such a market? Answer: you don't.

Oil rig at sunset |
Oil rig at sunset | Getty Images

The recent news from OPEC's recent meeting in Algiers, that OPEC will phase out its pump-at-will policy and start to cap and (for some countries) reduce output, is the first major change to hit the crude oil market since summer of 2015. 

At that time, Saudi Arabia announced that it would pump at virtually its maximum capacity with little regard for supply and demand. In other words, even after the world oil supply became a glut of oversupply, Saudi Arabia would keep pumping into the glut. For over a year, the Saudis have done just that. 

The results were great for some and nearly devastating for others. Drivers of non-electric cars were big winners. US drivers had grown used to $3 to $4 a gallon gasoline in the aftermath of the financial crisis. The Saudi move of 2015 dropped US prices to an average of $2.22 a gallon this week, a level consumers have grown used to. In Europe, cheap gas helped mitigate the pain of the stagnant economy, with gas in France now under $1.50 a liter. 

Among the big losers were the main enemies in the Saudi price war: US shale oil producers. Many of those companies have gone out of business, with thousands of wells capped and idle and the remaining firms struggling to attract investment or credit. The Saudis largely succeeded in knocking them out of the market and securing their market share. 

Others who were adversely affected include oil producers, including smaller OPEC members, whose cost of production is higher than Saudi Arabia's. It costs Saudi Arabia about $15 a barrel to get oil out of their ground. It can cost other countries $30 or even $50, which makes $50 a barrel oil barely profitable, if at all. Shale oil producers have a COP of around $60; that's why they couldn't make a profit once the Saudis caused world prices to drop. 

Add to that group the central banks of most countries, which worry that global deflation could lead to stagnation and a long, Japan-style non-recovery from the financial crises. The US Fed needs inflation to increase before it can safely raise interest rates. Higher oil prices would help the Fed, as well as the Banks of England and Japan and the European Central Bank to meet their targets and reduce deficits and debt. 

Reducing deficits and debt is also an issue for Saudi Arabia, which finds itself now with the largest budget deficit in the G20: roughly 13.5% of GDP. Its poorly diversified economy has slowed to 1 percent growth, compared to 4% for rival Iran. Iran, incidentally, won't need to cut production at all under the new OPEC agreement, since it was already low due to the recently ended sanctions. In short, Saudi Arabia agreed to help artificially increase oil prices because it had won its artificial price war with shale producers and now it really, really needs the money. 

Given that the crude oil market is ruled by such semi-rigged, chaotic factors, it's no wonder it's choppy. Can you still find trends to trade? Yes, but you have to use a zoom lens.

And what if you get in far from the top or bottom? Yes, because with limited risk binary options, you don't need to pick tops and bottoms.

The trend is your friend, even when it's small

In short-term trading, which includes scalping and swing trading, the exact definition of "long" and "short" is always up to the trader. Some people trade moves that last two or three minutes; others, two or three hours or days. But what's always true in trading is "Buy low, sell high." In the end, you find a trend. You buy at a lower price along that trend and sell at a higher price. Or you sell first and then buy. Either way, it's the same idea. 

How to pick tops & bottoms: Don't

In conventional trading (stocks, futures, forex) traders often fall into a bad habit of trying to pick tops and bottoms. It doesn't help that pundits on CNBC start calling the top of the bull market or end of a bearish move, as if they have some inside knowledge. They don't. 

Traders try to pick those tops and bottoms so they can set their stop-loss orders above or below them. Then they hope and pray that they won't get stopped out. That's really all there is, no matter how fancy your description of it is. You're guessing that it won't go any further than point A, so you won't get stopped out. 

At Nadex, you never get stopped out. Let's say you think crude is in a mini trend upward one morning and it will go from price A up to price B by 1pm. You buy a binary for $40. Even if crude reverses and the market tanks—the Saudis reverse their decision and all of OPEC starts pumping like crazy—you can't lose more than $40 (plus a 90 cent fee). 

You don't have to guess the bottom accurately. In fact, you don't really need to think about it, unless you want to. If you want to cut your losses before they reach the $40 maximum, you can get out early. The choice is yours. 

Try it for yourself. Open an account, fund with the minimum initial deposit ($250), and trade one contract for less than $100. Or open a demo account and try it with pretend money—but real-time market prices. See what the future of trading looks like and how it could work for you. 

This information has been prepared by Nadex, a trading name of North American Derivatives Exchange, Inc., prepared by independent third parties contracted by Nadex or reproduced form third party news agencies. In addition to the disclaimer below, the material on this page does not contain an offer of, or solicitation for, a transaction in any financial instrument. Nadex accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.