When It Comes to Crude Oil, Can You Trust How Markets Will React to News?

When It Comes to Crude Oil, Can You Trust How Markets Will React to News?

Trading into high-impact news can be a very risky proposition. Many traders opt to sit on the sidelines and let the markets digest the news after its been released. Others have strategies that capitalize on expected large price movement before the news is released. And some traders steer clear from any highly volatile event.

When It Comes to Crude Oil, Can You Trust How Markets Will React to News?
When It Comes to Crude Oil, Can You Trust How Markets Will React to News? Getty Images

On most Wednesdays, the Energy Information Administration (EIA) releases the Crude Oil Inventory Reports, which measure the weekly change in the number of barrels of commercial crude oil held by US firms.

Quite often, the actual report significantly misses analyst’s estimates. When that happens, there can be sharp swings in the price of Crude Oil futures within a matter of minutes. It’s not uncommon to see moves in excess of 50 ticks or better. If you are on the right side of the move, significant gains can be realized in a relatively short period of time. If you are on the wrong side of the move, significant losses can also occur.

What does the news really mean, and is there any rhyme or reason to how the markets will react once it’s released?

Let’s take a look at the Crude Oil Inventory Report Released on Wednesday, February 1.

When It Comes to Crude Oil, Can You Trust How Markets Will React to News?

Image courtesy of Investing.com

At 10:30am EDT, Crude Oil futures were trading at 53.116. When the news was released, the actual build was 6.466 million barrels versus 3.289 million barrels forecasted by analysts.  That’s a 3.177 million barrel miss in oil inventories, which would logically trigger a bearish response in the markets.

Now let’s take a look at how the markets reacted.

When It Comes to Crude Oil, Can You Trust How Markets Will React to News?

After a 10-minute expected move to the downside, the market sharply reversed and climbed to a high of 53.70 within 50 minutes after release of the news.

Why did this happen? The news was very bearish, and the market rallied. If you believe in simple supply-and-demand, then this move made absolutely no sense. This is where pundits make their money. It’s easy to sit on the sideline in hindsight and smugly opine why the market reacted in a manner contrary to fundamental economics. One analyst wrote that speculators chose to ignore the inventory build, and chose instead to focus on possible OPEC production cuts, which would ultimately drive up the price of oil.

If you trusted the actual inventory report and sold Crude Oil in the 10:30 news, you would have been briefly happy, followed by scrambling to get out of the trade to cut losses.

For my trading style, I don’t like to trade if there is divergence between the news and the market reaction. I always feel it will be a short-term reaction.  So I sat on the sidelines and waited for the rally to exhaust itself.

Looking at the chart above, you can see that the rally peaked at 11:20am, and then started to reverse. At 11:33, the following Nadex Spread trade was placed:

The Trade

  • SELL Crude Oil (Mar) 50.50 – 55.50 (2:30PM) – This is a 500 Tick Daily Spread, where every tick the market moves is worth $1.00
  • Entry Price: 53.51
  • Maximum Risk per Contract: $199
  • Maximum Reward per Contract: $301
  • Number of Contracts Traded: 1
  • Mental Stop/Loss: 30 ticks or -$30. I’m prepared to exit if the market moves 30 ticks against me.
  • Mental Take Profit: 30 ticks or +$30. I will consider exiting this trade if the market moves 30 ticks (or more) in my favor.

Here’s how Nadex Spreads work in a nutshell. In this example, your maximum risk ($199 per contract) is withheld from your account while the trade is active. If you let the trade settle at expiration, then your payout will be:

  • If the market is in your favor at expiry: You will get your risk money back, plus the number of ticks you collected for a maximum of $301, in this example. So if the indicative index settles 35 ticks in your favor from your entry price, then you get your $199 risk back, plus $35 in profit (exchange fees not included).
  • If the market settles against you at expiry: You will lose some or all of your risk money withheld. If the market settles 35 ticks against you, then your payback will be $199 less 35 ticks, for a payout of $164. Your maximum loss is $199, if the market moved 199 ticks (or more) at settlement, then your layout would be $0.I like to compare Nadex spreads to intraday traditional futures trading, with a hard floor and ceiling that protects you from catastrophic loss, but also places a cap on your upside potential.

Back to the trade. Once the trade was placed, the market made a hard reversal to the downside, and it blew past my Take Profit Target of 30 Ticks ($30). I gave the trade a little more room to run and exited the trade at 11:50 for a 52 tick profit, or $52, for a 26% return on capital risked (exchange fees not included). 52 ticks gained in 17 minutes.

What would have happened if this trade was held until the 2:30 Expiry?

When It Comes to Crude Oil, Can You Trust How Markets Will React to News?

You would have forfeited 37 ticks for a $37 loss (exchange fees not included).

After profit was taken at 11:50, the market waffled side ways for just over an hour, before ramping back up sharply and settling at 53.88, which was 37 ticks above my sell entry price of 53.51.

When you trade Nadex spreads, it is important to set profit and loss targets, and trade with discipline.

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