Forget about Organization of the Petroleum Exporting Countries (OPEC) deals. Forget about inventory reports. Forget about the economy “opening up” or “shutting down.”
If you want to make money trading oil, then there’s only one thing to watch… volatility.
As we saw from its recent 15% slide in just three days, the price of oil is volatile. It often moves 3-4% in a day and can swing 20% or more in a month.
That sort of volatility can lead to huge profits if you know how to trade oil the right way – or painful losses if you don’t.
Today, I’m going to share with you my favorite indicator to use for trading oil…
Take a look at this chart of the CBOE Crude Oil Volatility Index (OVX) along with its Bollinger Bands (BB)…
Similar to the stock market’s Volatility Index (VIX), the OVX provides buy and sell signals whenever the price of oil pops outside of its BB.
Bollinger Bands measure the most probable trading range for a stock or an index. When a chart pokes outside of its BB, it indicates an extreme move – one that’s likely to reverse.
On the OVX chart, we get buy signals when the index rallies sharply above its upper BB (four blue arrows).
Sell signals happen when the OVX drops sharply below its lower BB.
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Oddly, we haven’t had any sell signals this year. OVX did close below its lower BB three times, but none of those moves could be considered “sharply below.”
Here’s a WTIC chart to show how the price of oil behaved following each buy signal…
The price of oil rallied immediately following all three previous buy signals this year.
The March signal kicked off the start of a three-month rally where oil gained 30%. The July and October buy signals generated shorter-term rallies where oil gained about 12% in just a couple of weeks.
On Tuesday, the OVX chart triggered its fourth buy signal of the year.
I have no idea if this marks the start of a short-term or an intermediate-term rally phase for the price of oil.
But based on the accuracy of this indicator, traders should be looking for higher oil prices over at least the next couple of weeks.
Best regards and good trading,
Jeff Clark
Reader Mailbag
Where do you think the oil sector is heading next based on Jeff’s favorite indicator? Do you follow it as well?
Let us know your thoughts – and any questions you have – at [email protected].