Oil

Oil is Oil I thought.

Black, oily and highly volatile. For 10$ a tick and multiple 50 to100 tick runs a nice vehicle to trade.

But oil isn't oil. There are two major contracts to choose from:

CL N7 is Light Sweet Crude Oil

COIL N7-IPE is ICE Brent Crude

Both trading at 10$/tick and a minimum ticksize of 0.01

I assumed, that both contracts would trade side by side and tick by tick. It shouldn't made any difference whether you trade the CL contract or the COIL contract.

And that assumption was correct until March 2007. The CL contract traded with a premium of about 1$ to the respective COIL contract. But that began to change in April 2007. Take a look at this Spread chart I created of the continuous contract
COIL #F - CL #F

This is a daily spread chart and as you can see the spread has widened to about 5$ premium for the COIL contract now on a daily chart.

I became curious yesterday, when I noticed the pattern intraday as it became obvious for even the lazy observer. Here a 5 minute spread chart

After the announcement of the Oil Report the spread widened intraday from 4$ to 5$. You know what that means, do you? It means that the COIL contract is worth 1000$ more per contract at the close of yesterday compared to the CL contract with the same delivery and compared to the value of both contracts just a few hours before.

I have no explanation why the COIL contract is worth more now, but I know that this is an exaggeration. So how can you profit from that knowledge?

I assume the spread will narrow again. There is a clear trend to see favoring the COIL contract, but nonetheless Oil is still Oil and over the long run the spread should narrow again. Long Run? I'm not interested in the long run! I'm interested in intraday movements. And intraday I assume this 1$ increase in the spread we saw yesterday will be reduced today. Either by CL catching up or COIL coming down. Will see what happens...

Addendum:

What happened was, that the spread continued to widen to a maximum of 6.70$ with Light Sweet crude breaking down, while Brent crude continued to trade above 70$.

But I finally found an explanation why this is the case.

Read this article The sweet and the sour: a crude conundrum from Phil Flynn to understand it all.

Take the time

and read this article from Gladwell.com

It's about the one thing we usually avoid to think about: Blowing up

and it's worth reading.

My conclusion: Invest some time to think about the unthinkable, about the catastrophic event and find a way to hedge yourself.

What is the catastrohic event? You are long, something happens and the exchange closes. No stops triggered, the exchange is simply down and you have no way to get out of your position.

Yes I know, you could hedge on another exchange, but imagine that not working either or out of the question, because the unthinkable happened and all markets are down huge.

You think I'm crazy?

It doesn't take great imagination to come up with ideas, which would cause a shut down of the exchanges in New York or Chicago. And one of these doomsday theories will come true one day. The one, who has written about it, will then be questioned if it was a man made event causing it.

I only want to drive a point home, so I just deleted my idea from the article and leave it up to your imagination to come up with an idea, which would cause a shut down of the exchanges without triggering any stops.

It really might be a good idea to hedge myself against the unimaginable.

Comparing Apples and Onions

Apples are different from Onions. But both have a ball form, so why can't we compare them? Well every child will tell you, you can't, they are different. Still in TA we all have done it at times. Place two oscillators within one Window and see the Holy Grail. The crosses of these two oscillators look great, let's trade them

Here you see the TRIX oscillator against the Ergodic within 1 subwindow

That's not too bad on a first look. Unfortunately these 2 Oscillators have nothing in common. One is an apple, the other an onion. To compare 2 Oscillators, the least you need to do is making sure that both oscillators have the same range.

EG: Both have swings from 0 to 100 

But the TRIX and the Ergodic are calculated from price and are not normalized. Meaning the value range these 2 Oscillators swing in, is not fixed.

But there is a way to compare Apples and Onions! Just make them comparable. And the tool to do that is the Stochastic Oscillator. The Stochastic Oscillator normally uses the Close Price as input and it tells you where that close price is relative to the range of the last # bars.

EG: A Stochastic 14,1,1 takes the range of the last 14 bars and tells you where the last price is within that range on a percentage scale from 0 to 100% (0% being the low and 100% being the high of that range)

Now we know that any oscillator swings. Even when prices trend an oscillator tends to go flat. What we don't know with not normalized oscillators like the Ergodic or the Trix oscillator is the range these oscillators swing in. Still there is a way to change that. Ensign Software allows me to plot a Stochastic Indicator which uses not the Close Price but the Ergodic Oscillator Value as Input.

Use a very long range (as seen above I use a 400 bar range) and you will cover the relevant range the Ergodic moved in for the last few hours or days depending on your timeframe. The Stochastic will still be very sensitive, as the return value is the exact percentage value, where the current Ergodic value is within the range of the last 400 bars. Do the same with the Trix value and you get something very similar but not identical to the chart I showed above.

As you can see, while the arbitrary placing of the 2 oscillators within 1 window gives you a cross of both lines on the last bar, the placement within a fixed range of 0 to 100 and the correct placement of each oscillator within it's own range shows you no cross to the downside took place on the lbar prior to the last bar.

I can't tell you, if it makes any sense at all to trade crosses of the Ergodic with the Trix oscillator or slings of one oscillator against the other. The reason I wrote this article was to show you (and myself) a way to make apples comparable with onions, by placing them both within a common frame and then doing the comparison.

Suggested Reading

MarketWatch has a very interesting commentary today, which I recommend for reading, if you wonder how far these markets still have to go

Turning Japanese? from peter Brimelow

and a similiar article by Bill Fleckestein on MSNmoney

The Dow's dangerous winning streak