What is Up With Crude Oil?

A simple trading model built on monthly data will likely yield a buy signal for crude oil.  So what is up with that?

This is a purely technical model that utilizes two inputs for entry.  First, crude oil must be consolidating or range bound over a period of time such that there is compression in volatility.  Second, price must close greater than the simple 10 month moving average.  The exit strategy is a close below the simple 10 month moving average.  No other filters or inputs are required.

To test this model, I utilized the cash data for West Texas Intermediate crude oil.  The study started in 1989.  Since that time, there have been 10 trades; 90% were profitable.  The average trade lasted about 10 months.  This model was in the market about 36% of the time.  This strategy generated 86 crude oil “points” while buy and hold yielded 83.  The equity curve for this strategy is shown in the next graph.

Figure 1. Equity Curve

Figure 2 shows the maximum adverse excursion (MAE) graph for this study.  MAE looks at every trade from this study, and it measures how much a position moves against its entry position before the trade is closed out for a win or a loss.  MAE is the angst factor.  Look at the caret inside the blue box in figure 2; this represents one trade.  This trade lost 1.6% (x axis) before being closed out for a 30% (y- axis) winner.  7 out of 10 trades had MAE’s less than 2%;  this is extraordinary considering how volatile crude oil can be.

Figure 2. MAE Graph

To summarize, this model generated a return equal to buy and hold with only 36% market exposure.  In addition, the equity curve draw down was substantially less.  Observations are limited.  However, combined with fundamental inputs, this technical model could provide useful signposts to navigating a potentially volatile and hostile market.

Lastly, I will explore some of those fundamental drivers over the next couple of days.  In essence, that analysis will be broken down into decreasing supply or increasing demand.  A third driver may be as a hedge against currency debasement and inflation.

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Category: crude oil