Natural gas futures Wednesday remained locked in a battle between the competing forces of fundamental bearishness and technical bullishness. Buyers were the first to exert their influence Wednesday, propelling the prompt month to a $4.90 high in the first 35 minutes of trading. Bears battled back, however, and rerouted the market to the downside ahead of Thursday’s release of fresh storage data. December futures closed at $4.738, down 12.7 cents for the session.
Having watched the choppiness of prices increase over the last couple of weeks, market watchers have re-ignited the age-old argument over what moves natural gas futures price more: technical or fundamental factors. Although Wednesday’s price action might suggest a victory for the fundamental bears, some would argue that the absolute price level — at nearly $5.00 — is a resounding and undeniable endorsement that technicals and market emotion are the real price drivers for the market.
“This market has tested and failed to break down below the $4.60 level,” noted Sandy Trot, president of Trot Trading Corp. in New York. “As long as we continue to hold that level, this thing could go higher…. If weather turns bullish, that’s when you load the boat with longs.”
Trot has been a keen observer of the nuances of both technicals and fundamentals during his 21 years as a local trader and market maker at the exchange. Speaking at the “Managing Natural Gas Price Risk Workshop” in New York Wednesday, he appraised the post-Enron trading era: “Funds and local traders are having a larger and larger impact. You can’t look only at fundamentals and hope to be successful trading natural gas futures any more.”
To cite an example, Trot points to the market last Friday. Weather forecasts were bearish, cash prices were down, but yet the futures market was able to rally. “How does one explain this other than to say that there are other factors at work besides supply and demand?”
Also a speaker at the workshop, Tom Saal of Commercial Brokerage Corp. in Miami agreed that fundamentals fall short of what is needed for explaining and predicting market movements. “A strict supply-demand balance fails to predict price. Even if you know supply and you know demand, how do you know what price is going to be?” To back this assertion, he referred to the Energy Information Administration’s Annual Energy Outlook Forecast Evaluation. “Though it appears they have done a pretty good job of forecasting supply and demand, the EIA has registered 60-70% absolute error in predicting wellhead gas prices,” Saal noted (see related story). “Not too good a track record.”
This is not to say that Saal ignores fundamental factors entirely. Rather, he uses them in concert with other statistics and trading clues the market produces. One of Saal’s favorite pieces of market information is the Commitments of Traders report released every other Friday by the Commodity Futures Trading Commission. Specifically, Saal keys in on the behavior of the non-commercial segment of the market, who have consistently done a good job of buying the market on strength and selling the market into weakness. “Non-commercial traders have chosen wisely 72% of the time,” Saal assessed.
According to the latest CFTC report, these speculative traders are net short 52,244 as of Nov. 11. “Not since February of 2002 have they been this short. They appear to be reaching a saturation point… They are really pushing the market lower right now and helping out the buyers. If they weren’t in the market, prices would be higher.”
Trot also urged attendees at the workshop to take a disciplined approach to trading. You have to pick a technical trading system and stick with it, he said. One of the key technical tools he uses is Market Profile, which attempts to gauge market value by charting where the market traded on an intra-day basis. “A daily bar chart only gives you four pieces of data: open, high, low, close. With Market Profile, you get a deeper look at the market. For example, Market Profile can show you trading levels where the market spent considerable time or levels where the market barely traded at all.”
However, even the best technical systems can fail if the trader lacks discipline, warns Trot. “It is easy to get caught up in the emotion of the market and lose sight of your trading goals. [Wednesday] my system told me to sell December on a rally to the $4.89-91 level, but the market seemed to have so much momentum up there. It was so well bid that it look like it was going to $5.00. I held off (didn’t sell), and the next thing I know, the bids dried up, everyone’s a seller and prices are headed lower.
“This market can be punishing. I could have taken you all on a tour around the world and it would have been cheaper than coming to work today,” he lamented.
To minimize the risk of being on the wrong side of the market outright, Trot and other locals favor the use of spread trades, which involve the simultaneous purchase and sale of different months. With December set to go off the board next Tuesday, he is focused on the December-January spread in natural gas. “That spread was as narrow as 21 [cents Tuesday], but then blew out to close at more than 23 [cents Tuesday]. We could see it grow to 30 or 40 cents by expiration.”
Because buying the December-January spread infers buying January and selling December, Trot is betting on December falling in relation to January. “You will likely see some sort of convergence between cash and futures and that could drag December futures lower. Meanwhile, the funds are already short up to their ears in January. It will be hard for January to fall much in relation to December,” he reasoned.
Looking ahead, he notes that Dec. 15 is the day of reckoning for natural gas. “If the weather hasn’t showed up by then, this market will discount the winter entirely and prices will drop.” But that day is still four weeks out.
Ed Kennedy, also of Commercial Brokerage Corp. believes direction of the market is anything but definite. “We know what supply is, but we do not know what demand will be.” That being said, he suggests hedgers take advantage of the relatively low implied volatility — currently at just 57% — to buy reasonably priced options. “The actual strike price will depend on the individual buyer and what price level they need to protect,” he noted. “An example of a call that might work for some hedgers would be the to buy the $5.40 January call for 21.5 cents.”
Speculators, Kennedy continued, might want to take a look at buying the $5.40 call for 21.5 cents and simultaneously selling the $4.50 put for 16 cents. This strategy, termed an options collar will give the trader the upside benefit while only subjecting him or her to the downside risk should January futures fall below $4.50. The total out-of-pocket expense for this collar is roughly 5.5 cents, he said.
Trot also likes the use of options to minimize one’s risk and maximize your reward. “Options are like a printing press for money — they take the bumps out of the road and get you where you want to go.” As a market-maker, Trot typically trades 2,000 to 3,000 futures contracts a day, down from the 6,000-7,000 volume he moved in his heyday in the late 1990s. On a good day now, he might move 5,000 contracts, mostly using spreads as his trading vehicle. He estimates that local traders account for 40% or more of volume at the exchange.
When quizzed as to whether the existence of the open outcry system and local traders is good for the natural gas market, Trot is quick to note that liquidity and volatility are not the same thing. “We make markets. If it were just up to the orders coming in from brokers to produce trading liquidity, nothing would get done. You would have buy orders below the market, sell orders above the market and nobody making a move. [We] locals get in there and make a market. [We] facilitate the trading so that both the buyers and the sellers get filled.”
“It is not a mutual admiration society,” said Saal of the intense competition between locals. “It is Darwinian. They provide liquidity and compete against each other to provide the best services [for their customers].”
Another subject close to Trot’s heart is the debate over whether Nymex should go to 100% electronic trading. While he notes that it works in some markets, Trot is quick to point out that none of those markets trade as actively in the back months. “Again, it is the locals that promote that activity… I trade mostly in the front couple months, but will make a market out a year or more.”
©Copyright 2003 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.
© 2020 Natural Gas Intelligence. All rights reserved.
ISSN © 1532-1231 | ISSN © 2577-9877 |