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If you believe the price of oil is going to continue to drop, using an investment shorting vehicle like the VelocityShares 3x Inverse Crude Oil ETN (NYSEARCA:DWTI) would be a good way to play it, understanding taking a position in it could last less than an hour in some cases.
The goal of DWTI is to reproduce three times the inverse of the S&P GSCI Crude Oil Index ER, which is made up of futures contracts.
It is set up to provide oil investors believing oil will drop a chance to make some significant gains. For example, if oil were to decline 10 percent in a day, DWTI would climb 30 percent. The ETN is very volatile and shouldn't be held for a long time unless there is something bearish that will have a predictable negative impact on the price of oil. That could include the type of negative sentiment that generated downward momentum, driving the price of oil to about $26 per barrel.
Even if there is a predictable short-term outcome, it is still best to take profits and run when the chance is given, and not try to extract every drop of gain from the play.
What's interesting and potentially lucrative about using ETFs or ETNs to take advantage of quick moves either way, is an investor can enter or exit in the same day if the opportunity arises, making money on the way up and the way down. I've used this strategy with another commodity, which we'll get into a little later in the article.
Oil price movement near term
I see oil in the need of a pulling back after its recent rally. Most of it was based upon momentum coming from the so-called "verbal intervention" coming from the ongoing attempts to carve out a production freeze agreement among some producers.
With little in the way of fundamentals providing price support, it was inevitable the rally would weaken. It looks like that is where we're at now, and it be surprising if there isn't more downward pressure over the next couple of weeks.
Eventually the April meeting, if it occurs, will temporarily reverse the direction of oil, which those betting on the short side will need to consider the closer the day approaches. It will provide some support, at least until the news of what is decided, if anything, is released.
I'm not too excited about this because Iran won't participate, and Libya recently announced it wouldn't be attending the meeting either, for the same reason as Iran, which is to bring production back to prior production levels. In the case of Libya, it wants to go back to pre-civil war production levels, which was 1.6 million barrels per day. It only produces about 400,000 barrels per day now. That will improve as security improves.
Russia also made some unusual comments about the meeting, suggesting there's a possibility it may not take place.
The point is the production freeze agreement, which will be disingenuous even if there is some type of signing, because it locks in production at January levels, which was at a record post-Soviet high for Russia, and Iraq was also producing at record levels during the month.
Kuwait has said it won't agree to a freeze if the other don't, so we could see that come into play as we get closer to the date. For now, investors should assume the meeting will be in play, even if it is put off once again.
For now, I think it has been priced in, and there isn't a visible catalyst that would point to any further support. A stronger U.S. dollar will put further downward pressure on the dollar, as it strengthened on news the Federal Reserve may not be as dovish on raising interest rates as many thought after the recent comments from Fed Chair Janet Yellen.
On the short side traders need to be ready if Yellen comes out and reinforces her prior statements. That could also give a boost to oil prices in the short term.
Minus those caveats, there is a higher possibility oil prices will continue to fall in the near term than rise.
One of the strategies I've used
A way I've invested in similar vehicles has been to take a position consistently over a short period of time. Sometimes I would do it as much as several times a day, depending on the way the market was moving. That was done by dividing my capital into several equal amounts and trading off and on through the day.
Why I did it that way was it protected the trade at different price points in order to limit the effect of price reversals if they came quickly, which did happen at times; I was looking for an average in those circumstances.
I also did something like that on a consistent basis throughout a week or month, depending on what I was investing in.
Silver was one of my favorite targets when the price was climbing above $40 per ounce. Volatility is a friend of an ETN like DWTI, and it doesn't matter where the overall price is going over time if you work the short-term down trends. That's of course the same if you're betting on a commodity price rising. Interestingly, I made more money during daily volatility than I did on the price going up over a longer period of time.
That same strategy can be used with oil during big swings in prices, but the difference with oil right now is it really has no clear direction, which means it could move up and down while not making a lot of headway one way or the other. I could track silver much more predictably in the past than I can oil in the current market. Why that's true on silver's side is it is a much smaller market, and no matter what the trend is, there will be a lot of movement in the price. It can be counted on.
Oil is a much larger market and the disruption it is undergoing as a result of the U.S. shale revolution is making the price react in a way it hasn't in the past. The way Saudi Arabia and OPEC responded historically had been to adjust production one way or another to move the price of oil in the direction it wanted. With drilled but uncompleted shale wells, that is no longer a tactic that can be used because shale producers can bring supply to the market very quickly. There are approximately 5,000 DUC wells waiting to be brought into production in response to price increases. This puts a ceiling on the price of oil; one which has yet to be discovered by the market.
As for the strategy being mentioned here, if investors believe the price of oil will remain under pressure in the near term, it provides a type of dollar cost averaging methodology, even though the money is moved in and out of a position in the ETN over and over again. What I mean by that is there will be a variety of different price points to take a position in for the duration of the short-term cycle.
Be aware of the availability of your capital after making a trade. Some trading platforms require three days for to clear your money and have it available to invest. That's another reason I have broken my capital, so I don't miss out on quick moves. In a volatile market that can happen daily.
For those risk adverse to that type of investing, they could simply take one position at a time on a consistent basis, watching that one egg in the basket, ready to sell after generating a quick profit. I'm only saying I did very well using the strategy mentioned above.
The one downside in investing like this is you really can't take your eye off the trade. For that reason I have always had tight stop losses and a specific targeted goal for each trade. What traders have to be careful of more than anything is if they make a nice profit in the early stages of the strategy. This can easily produce the idea of being able to outsmart the market. We can't. The key is to be disciplined and realistic with the goals, and be willing to leave some change on the table. Resist the temptation of sellers' remorse if you could have made a lot more money on a trade. That discipline is what protects us from upping the ante to the point of taking some big losses and committing more capital than we should to this type of investing.
I've had times where I've enjoyed a lot of winning trades in a row. But eventually there will be losers as well, and retaining a disciplined approach helps protect capital and keep the overall trade profitably working for us.
The greed factor
I mentioned it earlier, but it's worth taking a closer look at the fact this type of trading can get addictive, especially when a trader enjoys some consistent success. This obviously can lead to greed, which I'm defining here as forgetting about the fundamentals of trading like this and continuing to let the trade ride, or move in and out of these trades with no discipline or strategy in place.
In short term trading there needs to be a lot of patience, even if patience is measured in hours or maybe a day, instead of months or years. What greed does is bypass patience in an attempt to force the gains from the market, rather than follow the immediate trend. Not only can you lose your gains when engaging in that behavior and outlook, but you can lose your seed capital as well.
What I'm saying is the adrenaline starts to flow when the prices start to move in our favor, and we can easily make a lot of mistakes when the dollar signs are in our eyes. This is why we need to take what the market gives us in the short term, and be willing to leave some of the money on the table. This type of trade is an investment in volatile price movements. Once that generates gains, we need to exit the trade quickly. Trying to extract every penny from the position will result in a weaker performance.
I've done a lot of these types of trades. This is how it works out. We need to take the quick gain and run, not linger in the moment in hopes of making a killing.
The VelocityShares 3x Inverse Crude Oil ETN was built for this type of investing, and it's why I prefer it against other ETFs or ETNs when the price of oil is falling. It moves up three times what the drop in oil is, and that provides an extraordinary opportunity to make some quick gains. It can also move in the other direction just as quickly, which is why the position has to be watched closely.
The decision to use DWTI should only be made if it is believed the price of oil will drop. Capital used shouldn't be anything that is targeted for long-term investments. This shouldn't be considered a unique "opportunity" to beat the market, but instead a chance to build up some of your capital said aside for riskier investments. The point is to generate some winners in order to expand the capital based used for these types of investments, while shaving off some of the gains and placing them into long-term, safer positions.
This shouldn't be considered an end in itself, but the means to an end.
If the risk is going to be taken on the downside of oil, it may as well be taken with the strongest upside potential in the short term. The VelocityShares 3x Inverse Crude Oil ETN gives us that.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.