What was your initial reaction when you woke up yesterday and saw that oil had fallen $5 or over 4%? Did you immediately place an order to buy Woodside Petroleum, or Oil Search or Santos? Or instead were you rushing to hit the sell button?
There are many different reactions that are possible when news hits the airwaves, but your trading is better if focused on pursuing a consistent strategy.
The traders that rushed out to buy are likely to be counter trend traders or contrarians, buying when everyone else is selling. To do this, these traders rely on determining oversold market conditions and buying when these occur. One possible way to do this is to use Bollinger Bands or Money Flow Index to determine when the share is oversold, and place buy orders according to these guidelines.
Santos in the above chart has reached an oversold condition touching the lower Bollinger Band, but has not quite moved into oversold territory on the Money Flow Index. When you look at the same chart of Woodside Petroleum, it clearly shows oversold conditions on both indicators. This would have the counter trend traders rushing to buy. It is however best to wait until a change of trend occurs as oversold conditions can become more oversold.
If a trend develops then the oversold conditions can continue for some time. In this case the trend traders step up to the plate and count on the trend continuing. Using the MACD to identify the trend in Woodside Petroleum the recent down trend paused for a few days before continuing on its way recently as the blue line crossed below the black line.
Oil Search on the other hand, saw the MACD turn higher, signalling a period of consolidation. No trade today, for the trend traders in Oil Search.
Now you might at this point be starting to get confused. The counter trend traders are buying Woodside, while the trend traders are selling. So what is the best approach? The answer to this question is both. Any strategy that is consistently followed will be profitable over a period of time. There is no guarantee that either trader will make money on this trade, but by consistently following a strategy you are likely to make money in the long term.
Right now my personal view is the trend traders may have an edge as the market heads lower. The Federal Reserve has halted the printing of money (Quantitative Easing, or QE2 for short), the situation in Greece seems about to reach a crisis point as a bailout package cannot be agreed on, and a sharp turnaround in the US dollar is likely as the Euro stumbles. There are signs of a slowing economy in the US and China is still attempting to slow down its own economy. All of these factors, along with the high prices of oil at present, could sustain a down trend for some time.
By Jeff Cartridge
The charts in the above article are taken from The Bourse charting and market data software. You can sign up for a 14 day free trial of The Bourse by visiting the Bourse Data website.