DTO: Shorting Oil For Fun and Profit

The black bands are what I used to test my proposed trailing stop, so that I knew the stop wouldn’t be triggered by previous consolidation periods.

Much of what I write about on this blog concerns short-term trading systems, or “swing trading”. That’s not because my portfolio consists mostly of swing trades…it’s doesn’t! Most of my money is tied up in longer-term plays. It’s just that, well, they’re not that interesting to talk about. You do your research, you buy the stock, and then you check in every once and awhile to see if it would like a sandwich or a cold beer. Which does not make for riveting reading.

But I just completed a trade that was a hybrid duration. Longer than a typical swing trade, but not a truly long-term proposition. That’s because I was “shorting oil”.

Back in December, there was a lot of talk about oil prices continuing to fall. This isn’t news to anyone who has been semi-conscious for the past few months. But at the time, those “in the know” were saying silly comments such as “oil won’t fall below $70/barrel” etc. Usually when people start saying something could never happen, those comments turn around and mug them in a dark alley. And meanwhile, the Saudis sounded very much like they were keen on having prices fall through the floor. I have my own geopolitical theories about that, but the ‘why’ isn’t all that important. When it comes to trading, ultimately the price is king. Suffice it to say, I thought it was a good bet that oil might fall to $50 or even – gasp! – $40.

Since I’m not currently prepared to trade options or short stocks, I looked around for a ‘reverse’ oil ETF. Basically this was a security that moved up when the underlying commodity moved down, and vice versa. I wanted to ‘short’ oil without all that pesky margin requirement for short selling.

So I found the PowerShares DB Crude Oil Double Short Exchange Traded Note (say that three times fast), ticker symbol DTO. Why did I pick the “double short” version? Because it uses leverage to double the inverse movement compared to oil. When I calculated the volatility of the “single short” version, it wasn’t enough to justify the amount of capital I needed to invest. In other words, the risk was too small to justify me tying up my money. I needed a higher potential return for the amount of capital I was willing to invest, and the double version fit the bill.

So how to go about this trade? I figured I’d be in it a few weeks or a few months at the most. I knew that this trade did not have the potential to last years and years, because oil would eventually head back up. So a trailing stop was in order, but a tighter one than what I would use for a long-term stock trade.

My first thought was “hmm, how about 2 X the Average True Range below the highest low of the trade?” The 14-period ATR at the time was 2.8681, so twice that is $5.74, rounding up. That was my proposed trailing stop. For each trading day that had a new higher low, my stop would move up so that it was $5.74 below that low. If a subsequent low was lower, the stop doesn’t move. The trailing stop only goes one direction…up. When the price finally closes below that trailing stop amount, I sell the next day.

Note that this stop, like for most of my trades, is not a ‘hard’ stop. I don’t act on intraday highs and lows, but only on the close of each day. If the close is below the stop, I sell the next day at the opening bell.

I did some quick calculations to see how the stop would have fared during earlier consolidation periods in the recent run up. I wanted my stop to be loose enough to make it through these consolidation periods without “stopping out”, but not so loose that I gave back too much profit when the tide turned. You can see the bands I tested on the first image above. The stop I had picked gave just enough wiggle room.

So how did I do? Pretty well, thank you! I did give back a sizable chunk of money in the past couple of days. But even so, I bought this at $68.87 on December 11th, and sold it this morning for $95.30. That’s gain of 38% in about seven weeks.

The pink line is where my trailing stop ended up, which was then hit on Friday’s close.

I must admit, it’s been perversely fun to root for oil to keep falling. Money in my gas tank and money in my portfolio at the same time! But it did also suck that the rest of the market (and the rest of my portfolio) has been less than happy with the falling price of oil. Perhaps oil is finally slowing its descent, and maybe the markets will stabilize.


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