While natural gas futures trading decisions based on rig counts and data from the Energy Information Administration (EIA) on gas production and consumption may be easy to explain to a corporate chief risk officer, technical indicators, such as moving averages and stochastics, do a far better job of not only signaling when a price trend is about to turn, but also the size of an impending rally or retreat, said Tom Saal of Miami-based Commercial Brokerage Corp.

Part of the reason fundamentals are so inadequate is their poor quality, Saal said at GasMart/Power in New Orleans. Much of the data from EIA are typically three to six months old and often revised repeatedly. EIA even admits that its own wellhead natural gas price forecasts suffer from a 70% average absolute error.

But where the fundamentals often fail miserably, there are plenty of technical tools available to reliably predict market changes. One of the primary technical tools Saal uses to identify when a price trend is about to reverse are stochastics. Stochastics are short-term price momentum indicators that compare current prices with prices during earlier periods. Comparisons with longer periods are used to create the slow stochastics, and comparisons with shorter periods are used to create the fast stochastics. When the fast stochastic (a number between zero and 100) moves above the slow stochastic and the market is in an oversold state, prices are projected to move higher. Conversely, when the fast stochastic moves below the slow stochastic and the market is overbought, the market is projected to move lower, according to Saal.

However, using stochastics alone is not enough, and Saal recommends the use of several additional technical systems in concert with each other. Price patterns are extremely important and widely accepted technical tools. “The ‘W’ bottom is a very powerful formation that usually signifies the end of a downtrend and the beginning of an uptrend.” Meanwhile, tops are usually spikes that occur in peak demand winter periods. “Because gas is used primarily for space heating, people are willing to pay any amount for gas in the winter,” said Saal.

Another powerful tool is the moving average, used successfully by non-commercial fund traders. Using back-testing of 1,250 trading sessions, Saal showed that a simple strategy of buying or selling one contract when the prompt contract moved above or below its 40-day moving average netted a $75,160 gain.

Discipline is the key, he said. “You have to be prepared to take some losses in order to achieve gains.” For example, Saal calculated that of the 57 trades across the roughly five years tested, only 36% would be winners. Even more discouraging is that a trader adhering to this strategy would have had to endure eight straight losing trades at one point. Nevertheless, you have to stay the course, Saal said, or risk missing out on the big move (December 2000 peak at $10).

But while trading based on the 40-day moving average would have paid dividends in the natural gas market over the past five years, it would have yielded a net loss of $12,490 in crude oil over the same period, Saal said. “There is a 50% chance that the price of any two commodities will move up or down together,” he said, casting doubt on the belief that there is any real correlation between natural gas and crude oil.

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