Playing The Oil Trend With UWTI

| About: VelocityShares 3x (UWTI)


The VelocityShares 3x Long Crude Oil ETN allows for traders to make three times the profits when investing in the oil trend.

Finding the bottom of West Texas Intermediate oil prices is the best way to determine a buy signal for an oil exchange-traded fund.

While downside risks are real, a rally into the $40s could keep the price of crude oil in a trading range above its February bottoms.

The best way to cash in on a trend in crude oil is not by buying and selling the contracts, but watching ETFs that track their prices. Over the past two years, these exchange-traded funds have become very popular as oil prices plunged to sub-$30 levels. In a MarketWatch article, the VelocityShares 3x Long Crude Oil ETN (NYSEARCA:UWTI) was cited as being the fifth-most traded security by Millennials.

UWTI is hardly a tool for hedging against the risk of volatile oil prices. Instead, traders use the derivative as way to bet on different oil trends, hoping to cash in on the accelerated payout it offers. This ETF generates a whopping 119 million shares of average volume, despite year-to-date losses of over 38%. Its popularity trumps both the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA:OIL) and the United States Oil ETF (NYSEARCA:USO), which average about 5 million and 51 million shares, with YTD losses below 25%.

There's no doubt that UWTI provides traders the opportunity to cash out on an accurate projection of oil prices, but its high leverage and volatility can translate to large, sudden losses if a trend reverses. The best way to reduce risk created by unexpected, short-term fluctuations is to buy at the very bottom of the trend and hold until it tops off in the long run. With the market beginning to tame, investors should start to consider this trade before it's too late.

During the week ending March 12th, the price of West Texas Intermediate contracts rose from the low $30s as investors finally saw production slow down. Baker Hughes reported earlier that week that rig counts fell to an all-time record low of 480, instigating pent-up bullish sentiment. Recent evidence showing a decline in production has caused gains of just over 20% in the past month of trading sessions.

While analysts are looking forward to a smaller supply in the future, traders can't ignore the risks of the current fundamental situation, which is still oversupplied by the extra oil still sitting idle in storage. Given how volatile oil trading has been over the past year and a half, skeptics have reason to doubt the rebound and may even see another plunge coming. That would mean complications for those waiting to bet on a bottom.

I'm here to tell you not to worry. It's time to bet on that bottom.

3 month Deviation Moving Average for WTI crude oil contracts

Introducing the Deviation Moving Average first published and constantly updated on my blog here. This indicator is similar to a trend line, with an adjustment that accounts for a constant deviation in price. The blue line follows WTI price, and is coupled with the orange line, a 50-day moving average plus the 10-day moving average of the actual price's deviation from its 50-day moving average. With this enhancement, traders can track actual price movements against a deviation that the group has determined is acceptable. Because of intraday trading, the actual price will move either above or below its trend line. Crossover points show a reversal in short-term sentiment. The gap (length of time over or under the orange line) between each point is usually the same size, and the variance (absolute value of the difference between the two lines) peaks at about the same height.

This idea can be better visualized by the difference chart which is plotted over the past year. In the very volatile 2015, the gaps of smaller sentiment trends lasted just under a month, with variance peaking at about $4.00. Using these observations, investors can predict where a small reversal may take place and where the momentum of those reversals are pushing the overall trend.

Looking back at the first chart, one can see a curious trend that has developed over the past month. The actual price has not crossed over its deviation moving average line since February 12th, 2015. In fact, the variance has continued to stay constant despite reaching a difference of over $5.00. If the volatile trend of 2015 were to continue, WTI price would have started to fluctuate back downward about a week ago. So, why has this not happened? Why has the gap been sustained?

The chart shows a change in trend that occurred because of the shift in expectations from oil & gas investors. With the lower rig utilization and the hope of OPEC members freezing output, the buzz saw trend has softened with stability in the long-term price a reality. The new, smaller price channel that emerges might not reach above $50, but it will ease the uncertainty that has plagued oil corporations and oil exporting countries.

Because UWTI is a derivative based on the price of oil, volatility there will begin to soften like it has in the WTI spot price trend. As the danger of a sudden plunge in price wanes, it will be safer to establish a long position consisting of UWTI or other energy ETFs. From there, one can ride a long-term trend upward without having to worry about a replay of the bearish tsunamis that drowned out the first month of 2016.

Even if WTI were to crossover its deviation moving average in the near future, that point would be linger around the low- to mid-$30 range, which is far from the bottoms established in January. With the deepest valley in the past, a smooth, upward climb for the price of oil will allow investors to cash out using the accelerated UWTI exchange-traded fund.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.