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After peaking in April, oil fell as much as 14%. You can see the slump in the chart below.
Oil majors took it on the chin too…
Exxon Mobil (XOM) fell 12% from its April peak. That has it trading where it was in October last year… and the October before that.
Chevron (CVX) has also been drifting. It’s trading right where it was back in February 2022.
With the recent weakness in the oil sector, you’d likely be surprised that my readers recently had the opportunity to make a 40% gain in just two days on an oil trade.
To put that in perspective, the average annual gain of XOM and CVX over the last decade is 6% and 7%, respectively. So with one trade, you could’ve outperformed these bluechips in less than a weekend.
Today, I want to share how that trade played out so that you can take advantage of similar opportunities. You just have to know how to find them.
And it’s not as hard as you think…
Understanding Basic Patterns
I’ve been studying the markets for 40 years now. And every day, I look at dozens of charts.
That’s part of being a trader. You need to understand how markets are moving.
It looks complicated… But it’s simpler than you think.
And one of the first things to know is this: Prices never go in a straight line.
Even in the strongest rallies, there will be days (or weeks) when the stock goes through a pullback.
It’s the same when stocks are falling heavily.
Bargain hunters will temporarily push prices higher against the prevailing downtrend.
And this basic price action lies at the heart of my trading strategy.
I look for stocks that have overshot in either direction… They’ve either rallied too hard or fallen too steeply.
And I look to profit when they snap back the other way.
In formal terms, we call this a “mean reversion” strategy.
And even the smallest price reversals can generate outsized gains.
That’s what we did with our recent trade on the United States Oil Fund (USO). USO tracks the crude oil price.
As you can see in the chart below, USO peaked in early April before heading into a downtrend.
United States Oil Fund (USO)
Source: eSignal
But our momentum indicator, the Relative Strength Index (RSI), warned me that USO was approaching oversold territory.
That hinted it could be preparing to “snap back” higher. We just needed to be patient and wait for the right trigger.
When the RSI is rising, buying momentum is increasing. That typically pushes prices higher.
If the RSI overcooks and reverses – like at “A” – it can lead to a stock rolling over and falling.
You can see it on the chart. The RSI reversed (black arrow) and fell from overbought territory. That pulled USO lower from its April peak.
So we watched for a trade setup to capture an RSI reversal from oversold territory.
When you see a “V” forming like this (inside the red circle), it can often lead to a sharp bounce.
And that provided the trigger for our trade…
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The Trade
As we anticipated, the RSI reversed higher. On June 4, we opened a long USO position by buying a call option. A call option increases in value when the underlying stock rallies.
And as the chart shows, we got our timing exactly right. Our entry coincided with USO’s low.
Take another look:
United States Oil Fund (USO)
Source: eSignal
USO’s rebound higher putour trade immediately into good profits.
Withour position up strongly, we exited our trade on June 6 by selling our call options for a 39.7% gain after just two days.
This is how you can pull forward years’ worth of market returns in just a few days.
To be clear, using options magnifies gains and losses compared with trading shares. Had we just bought shares instead, our gain would have been just over 3%.
And because options have a finite life, the clock is always ticking. Meaning that time decay is constantly eroding the value of your option.
If the trade doesn’t go your way and you hold till expiration, your option can expire worthless. That’s the risk.
We manage this by position sizing appropriately. It’s never wise to put more than you can afford into a single trade.
But when you get it right, you can be in and out of your trade for a tidy profit.
And keep in mind, we’re not trying to pick a major change in trend with this “mean reversion” strategy.
Instead, we’re simply looking for a stock that is overstretched. Then we look to profit when it snaps back the other way.
And with a little practice, you can learn how to spot these opportunities yourself.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict