This 'Crazy' Trade Might Not Be So Crazy After All
If you take a quick look at a chart for oil futures such as that below for the E-Mini WTO contract QM, without any additions, you might conclude that buying right now would be suicidal. It certainly goes against the frequently quoted advice to traders never to try and catch a falling knife. Add a simple line at the 52-week low, however, as I have done here, and buying doesn’t look so crazy as that level looks like a significant bottom.
In fact, it does require a particular kind of craziness, but it is one that traders have to have innately or to develop if they are to succeed.
The popular perception of traders is of supremely confident, Masters-of-the-Universe-in-their-own-heads type people. The reality is usually a little more complex than that. You need the kind of arrogance that can cause you to look at a chart like that and decide to buy, but you also need the humility to know that you could be spectacularly wrong. That is pretty much the definition of a split personality, but preparing for possible defeat is a perfectly sane, logical thing for a trader to do.
That kind of split personality is only any use to you if you not only acknowledge that you could be wrong, but also prepare for the eventuality. That means setting a level at which you will accept defeat and stop yourself out of your position, which in turn means identifying a level at which it is obvious that you were wrong.
That is where the blue line on the chart comes in.
A break of a support level as clearly defined and clearly significant as that low around 50.50 fits that description. It is a logical level off which to set a stop-loss for a long position, at say just below $50.
Even if you can see and accept that, I am sure many of you are asking the next logical question. If that is the key level, why buy now? Why not wait until QM gets there?
The answer lies in what happened the last time we approached that low. On October 3 last year, crude, which was in full collapse mode then as it is now, stopped just short of it and bounced quickly. That is something that happens frequently and is perfectly logical.
Once a support level is established, buying in front of it rather than at it makes sense for most traders as it makes it much more likely that you order will be filled. That is what happened in October, and it could easily happen again here.
So far this morning, there are signs that a bottom is forming at around $52. At the time of writing, QM had got there three times, bounced each time and is trading at around 52.60.
Of course, all of this is based on technical analysis, and if the fear of coronavirus continues to dominate trading, none of it will matter. That, though, is why both confidence and fear have to be present in a trader. Understanding that and placing a stop-loss order that will keep losses to a minimum results in a good risk/reward ratio, and that makes the risk of buying crude in anticipation of a bounce one worth taking no matter how crazy it seems at first glance.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.