02 Oct Writing a trading plan — part 2

Writing a trading plan

Part 2

Correlations with crude oil

One of the best sources out there for learn­ing any­thing about trad­ing is def­i­nite­ly with­out a doubt; Investo­pe­dia. So many high­ly pro­fes­sion­al con­trib­u­tors and knowl­edge to be found there. That is also where I found this arti­cle on ‘Build­ing the Per­fect Mas­ter Plan’ by Matt Black­man.

So thanks to Matt and thanks Investopedia.

Part of a series

This is the sec­ond part of ‘writ­ing a trad­ing plan’. Not sure how many parts it will have because that all depends on how much work each part will take to write. I will con­tin­ue this series until I have a work­ing trad­ing plan that I can be con­sis­tent with. I will men­tion all mis­takes and things that did go well to the best of my abil­i­ty and in all hon­esty. Thanks for tak­ing the time to read it. 

Writ­ing a trad­ing plan. Part 1.

Treat­ing trad­ing like a business.

First get this through your thick skull

But before we start I’d like to say the fol­low­ing. Yes, I am trad­ing a very small account and some may laugh. That’s OK. This is my jour­ney and I believe that I need to fol­low my own path and aim for con­sis­ten­cy before I risk too much. It’s not that I can’t lose thou­sands of dol­lars, but why would I risk it? At this point I am get­ting more lucky than actu­al­ly being good. I under­stand this and I accept this. We have to be hon­est with our­selves and acknowl­edge when it’s an abil­i­ty or just sheer luck. So many brag about their gains, but you nev­er hear them on their loss­es. Not me. I strive to be good at this. I don’t gam­ble. I don’t believe in luck. I believe in my plan. And the only way to do this is to be hon­est. I have no ben­e­fit in lying to you because that means I’d be lying to myself. And that is what you will read here. So go on. Mock me. Or… read on and hope­ful­ly I con­tribute some­thing to your jour­ney in becom­ing a trader.

DISCLAIMER

Click here for my dis­claimer. It basi­cal­ly says that I am on my path to becom­ing a trad­er and these are just my opin­ions on how to approach learn­ing to trade. Feel free to check it out and com­ment on it.

Here it goes…

Writ­ing a trad­ing plan is like writ­ing a busi­ness plan. After all, don’t you think that trad­ing is a busi­ness? I hope you don’t think it’s gam­bling. Even though there is some­thing to be said about gam­bling being a busi­ness as well. Of course I got to see the casi­no busi­ness from up close in Macau and pon­dered their strate­gies and how they play with our emo­tions. Read that arti­cle here. There is also some­thing to be said about an indi­vid­ual treat­ing gam­bling as a busi­ness. Look at all the pro­fes­sion­al pok­er play­ers. Do you actu­al­ly think that play­ing pok­er is con­sid­ered gam­bling to them? If you take the time to mas­ter any­thing it is not just about gam­bling any­more. It is about beat­ing the odds. Increas­ing the prob­a­bil­i­ty of win­ning and keep­ing your loss­es short. This all, my friend, starts with a busi­ness plan.

Do your homework

Before you start your trad­ing day you need to set your­self up with your bias on how to trade for that day. Accord­ing to the U.S. Ener­gy Infor­ma­tion Admin­is­tra­tion (ie. the EIA a.k.a. ‘The ora­cle of crude oil’ to most peo­ple) there are a shit­load of fac­tors that influ­ence crude oil. And I’m sure they’re right. Here is the list if you care to have a look at it. 

For now, I will focus on just a part of it though. Fac­tors that I think have a big­ger and more imme­di­ate impact on crude oil prices than oth­ers are:

• News cycles:
  • Amer­i­can Petro­le­um Insti­tute (API) report usu­al­ly on Tuesdays
  • Ener­gy Infor­ma­tion Admin­is­tra­tion (EIA) report usu­al­ly on Wednesdays
• Times of the threat of a war and actu­al war going on puts upward pres­sure on oil
• There have been ris­ing cor­re­la­tions in oth­er com­modi­ties and oil
  • Nat­ur­al gas — pos­i­tive correlation
  • Gold — pos­i­tive correlation
  • Cop­per — pos­i­tive correlation
  • Sil­ver — pos­i­tive correlation
  • Soy — pos­i­tive correlation
  • Corn — pos­i­tive correlation
  • Wheat — pos­i­tive correlation
• Also, cor­re­la­tions between crude oil futures and finan­cial invest­ments have strengthened
  • S&P 500 — pos­i­tive correlation
  • U.S. dol­lar — neg­a­tive correlation
  • U.S. Bonds — neg­a­tive correlation
  • WTI implied Volatil­i­ty — neg­a­tive correlation
  • Infla­tion Expec­ta­tions — Pos­i­tive correlation

When I say focus, I just mean to take these fac­tors into con­sid­er­a­tion a lit­tle bit. The mar­ket has proven more times than not to be errat­ic. At least to an ama­teur like me. 

News cycles

I already wrote about the API and EIA report so go check them out here. Basi­cal­ly, I will take into con­sid­er­a­tion when these reports are released and watch what hap­pens. Usu­al­ly the mar­ket reacts even more errat­ic than usu­al but per­haps I can catch a wave or two. This is some­thing that I am still fig­ur­ing out. I’ll prob­a­bly write a more detailed approach on them later.

Geopol­i­tics

It’s usu­al­ly a good thing to be on top of the news regard­ing any war. Espe­cial­ly when two big babies with dad­dy issues have access to nuclear weapons. In the grand scheme of things I believe that ‘news’ (fake or not) is just a cause for finan­cial mar­kets to go up or down. This might be a cold thing for me to say, but as a day trad­er I want volatil­i­ty. I don’t have use for prices mov­ing at the same lev­el. Prices need to go up and down so I can take posi­tions on rid­ing the wave of them. So where do I go for my geopo­lit­i­cal needs? 

• https://news.google.com

Finan­cial headlines

As a gen­er­al rule, I think it’s wise to heed the head­lines of the finan­cial mar­kets. For me that is skim­ming through Bloomberg and CNBC. At a lat­er point I’ll prob­a­bly invest in a paid sub­scrip­tion ser­vice. I’d need to research this first of course and will ded­i­cate an arti­cle on it.

• www.bloomberg.com
• www.cnbc.com

To look for arti­cles more relat­ed to WTI crude oil, I read up on www.investing.com. There it’s easy to look up what you want and find an aggre­gate of all relat­ed arti­cles pub­lished by dif­fer­ent sources.

So for more focused infor­ma­tion on the finan­cial instru­ment I trade, WTI crude oil futures, I use the following:

• www.investing.com/commodities/crude-oil-news
• and Twit­ter
  • I have sub­scribed to sev­er­al ‘author­i­ta­tive’ fig­ures on WTI crude oil.

Com­modi­ties and Currencies

I find that it would make sense that there is some­thing that cer­tain ele­ments in any econ­o­my are inter­twined. Espe­cial­ly when you con­sid­er that most of the world’s valu­ables are tied to the US dol­lar. So a sim­ple deduc­tion would make you assume that if there is an up- or downtick in the cur­ren­cy it would cre­ate a wave trick­ling over to those com­modi­ties. The ques­tion then aris­es how big is that wave?

Dol­lar Dol­lar bills y’all

Because crude oil is quot­ed in USD it gen­er­ates imme­di­ate realign­ment between the Dol­lar and oth­er Forex pairs. Espe­cial­ly, coun­tries with sig­nif­i­cant crude oil reserves. Coun­tries like Cana­da, Rus­sia, and Brazil. Japan, that doesn’t have a sig­nif­i­cant oil reserve, has less cor­re­la­tion with this fluc­tu­a­tion in crude oil prices. So what does this mean? I think it means that when there’s move­ment in crude oil prices this affects the cur­ren­cies but not the oth­er way around. Unless it’s the US dol­lar. That does have an inverse cor­re­la­tion to crude oil prices because if the USD goes down, crude oil is bought in USD, that means the val­ue of crude oil goes down. The intrin­sic val­ue that is. Mean­ing that when the USD los­es val­ue, it costs more dol­lars to buy the com­mod­i­ty but buy­ers using for­eign cur­ren­cies, that now can buy more dol­lars can thus buy more crude oil. 

The Five Families

That’s a mafia ref­er­ence by the way, but I’m actu­al­ly talk­ing about five major asset classes: 

• Trade-Weight­ed U.S. dollar
• U.S. equi­ties ( as rep­re­sent­ed by the S&P 500)
• Emerg­ing mar­ket equi­ties (as rep­re­sent­ed by the MSCI Emerg­ing Mar­kets Index)
• the U.S. 10-year Trea­sury Yield
• and the U.S. 5‑year Trea­sury infla­tion breakeven spreads (the spread between 5‑year TIPS and nom­i­nal Treasuries)

There seems to be a very high cor­re­la­tion with risky assets such as equi­ties, gov­ern­ment bonds and the infla­tion expec­ta­tions that they rep­re­sent. In fact, accord­ing to this arti­cle, “it would be a rare event to see the price of crude oil and any of these oth­er major assets not mov­ing in the same direction.”

Com­modi­ties and the USD

The price of com­modi­ties and the strength of the dol­lar have an inverse rela­tion­ship. Typ­i­cal­ly, when the dol­lar strength­ens against oth­er major cur­ren­cies, the prices of com­modi­ties tend to drop and vice versa. 

The CRB index con­tains a diverse group of com­mod­i­ty prices against a chart of the dol­lar index which rep­re­sents the strength or weak­ness of the U.S. cur­ren­cy against oth­er for­eign exchange instru­ments. As a rule, when the dol­lar moves high­er, the com­modi­ties tend to move lower.

The best way to keep an eye on the dol­lar is to watch the price quotes of the Dol­lar Index trad­ed on the ICE Futures Exchange.

Man! What does this all mean?!

So I am still fig­ur­ing out if any of this actu­al means some­thing in my trad­ing. So in order to find out I will have to explore cer­tain things a bit more and actu­al­ly do my own research on it. How­ev­er, I have kind of estab­lished myself to be a scalper/daytrader and have some ideas on how I trade. Based on that I will make a strat­e­gy and test that strat­e­gy to see if it works. I think these items dis­cussed in this arti­cle work for those that trade big­ger time frames. Hav­ing said that, I do think it will pro­vide me with a cer­tain bias (up- or down­trend) for any giv­en day. This is some­thing that I will have to find out. Of course, I will write an arti­cle about it here. Fur­ther­more, I will make a sched­ule for myself to plan all these tasks in it. 

Things to explore

• The CRB index
• the dol­lar index futures contract
• S&P 500
• MSCI Emerg­ing Mar­kets Index
• the U.S. 10-year Trea­sury Yield
• and the U.S. 5‑year Trea­sury infla­tion breakeven spreads (the spread between 5‑year TIPS and nom­i­nal Treasuries)

My resources

• http://www.futuresmag.com/2016/03/16/crude-correlations
• https://www.cnbc.com/2017/03/06/the-correlation-between-usd-and-commodities-is-now-gone-citi.html
• http://www.investopedia.com/articles/investing/072515/top-factors-reports-affect-price-oil.asp
• https://www.thebalance.com/how-the-dollar-impacts-commodity-prices-809294
• http://www.investopedia.com/articles/forex/092415/oil-currencies-understanding-their-correlation.asp
• http://www.investopedia.com/articles/forex/090315/two-great-currencies-profit-oil-volatility.asp
• https://www.thebalance.com/how-the-dollar-impacts-commodity-prices-809294

Thank you

Thanks for read­ing. If you have any com­ments or ques­tions please feel free to post them below.