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On August 28, 2014, October natural gas generated a short-term buy signal.

On September 3, October natural gas  generated a short-term sell signal.

We are reprinting reports on natural gas beginning on August 28 through September 3 when natural gas reversed the short-term buy signal of August 28.

The purpose of this review is to show prospective clients how we approach markets once a buy signal has been generated, and it turns out to be false. False signals occur with a certain amount of regularity regardless of the system used. However, false signals occur far less frequently using OIA protocols because of refinements made over the course of several years. In essence, when a buy/sell signal is generated, it typically represents an extension of a move that may have begun days or weeks prior. Thus, in the case of natural gas once the buy signal was generated on August 28, the market by our definition was over extended and due for a correction. Typically, the correction lasts from 1-3 days, and if a market corrects beyond 3 days, the signal is suspect. During the 1- 3 day corrective period in natural gas, we evaluated a variety of factors to determine the strength of the buy signal. The reports below highlight the analytical process that kept clients on the sidelines.

 

From the August 28 report on natural gas:

“Natural gas: On August 28, October natural gas generated a short-term buy signal, but remains on an intermediate term sell signal.”

“October natural gas advanced 4.1 cents on volume of 284,053 contracts. Volume declined somewhat from August 27 when October natural gas advanced 5.4 cents on volume of 301,253 contracts and total open interest increased by 10,048 contracts. On August 28, total open interest increased again, this time by 11,099 contracts, which relative to volume is approximately 55% above average meaning that new longs were aggressively entering the market and sending October natural gas to a new high for the move at 4.101, which is the highest print since July 17 (4.110).The September contract lost 293 of open interest and the October 2014 through December 2015 contracts all gained open interest.”

“As we said in yesterday’s report, in order for October natural gas to generate a short-term buy signal on August 28, the low for the day had be above OIA’s key pivot point of 3.954 and the low in yesterday’s trading was 3.973.Usually, after the generation of a buy signal, the market has a tendency to pullback from 1-3 days, and this is the opportunity to initiate bullish positions. We think this is especially likely because during the past 2 sessions, total open interest has increased substantially.This makes the market vulnerable to a correction because new longs have a tendency to cut potential losses on new positions. We are in the early stage of the season, and the market will have its normal backing and filling. In short, there will be a more opportune time to initiate bullish positions.”

 

From the August 29 report on natural gas

“October natural gas advanced 2.1 cents on volume of 177,070 contracts. Total open interest increased by 5453 contracts, which relative to volume is approximately 20% above average. The October contract accounted for loss of 35 of open interest. As this report is being compiled on September 2, October natural gas is trading sharply lower down 3.37%, or -13.7 cents. The strength of the downside move surprises us, but we warned clients to wait for a pullback that we said would last 1 to 2 days. This is the first pullback since the generation of the buy signal on August 28. Continue to stand aside.”

From the August 31 report on natural gas:

Due to the length of the August 31 report, we are providing the extract relating to the buy signal.

“Now that October natural gas has generated a short-term buy signal, the market should have a small pullback lasting 1 maybe-2 days, and this is the opportunity to initiate bullish positions. October natural gas should find support at 3.930, slightly beneath the lows of August 26 (3.936) and August 27 (3.932 ) and the 20 day moving average of 3.932. The 50 day moving average is 4.050 and October natural gas closed at 4.065 on August 29, which means the pullback may be very shallow and short-lived.”

“The first indications the buy signal is false would be a close below $3.906, then 3.856.”

 

From the September 2 report on natural gas:

“October natural gas lost 17.5 cents on volume of 303,606 contracts. Volume was slightly above that of August 27 when October natural gas advanced 4.5 cents on volume of 301,253 contracts and total open interest increased by 10,048 contracts. On September 2, open interest declined only 2,334 contracts, which relative to volume is approximately 65% below average. The October contract lost 7,313 of open interest. We consider the minor decline of open interest on a very large decline to be bearish. The reason for this is that there was a large build of open interest as natural gas prices advanced.”

“For example from August 27 through August 29, October natural gas advanced 11.6 cents while total open interest increased by 26,580 contracts. In short, there are large numbers of speculative longs who are showing losses, but have not liquidated. This group will continue to exert selling pressure on the market, which will keep a lid on advances.As we said in the August 31 weekend report, a close below $3.906 and then 3.856 would be a sign the buy signal generated on August 28 was false. Yesterday, October natural gas closed at 3.890, below the first pivot point. As this report is being compiled on September 3, October natural gas is trading down 4.1 cents on low volume and has made a low for the day of 3.829. We advise a stand aside posture even though this is the second day of the pullback. We think there is a good chance that the buy signal is false.”

 

From the September 3 report on natural gas:

“Natural gas:  On September 3, October natural gas generated a short-term sell signal, which reverses the short-term buy signal of August 28. October natural gas remains on an intermediate term sell signal.”

“October natural gas lost 4.3 cents on volume of 246,895 contracts. Total open interest increased by 712 contracts which is minuscule and dramatically below average. The October contract accounted for loss of 5,394 of open interest.On August 28, October natural gas generated a short-term buy signal, and since then has acted poorly.For example, October natural gas closed below OIA’s key pivot point of $3.906 on September 2 and yesterday closed at 3.847, which is below the second key pivot point. Although total open interest has increased by 26,580 contracts between August 27 through August 29, when October natural gas advanced 11.6 cents, we have not seen a corresponding decline of open interest during September 2 and 3. This means there are market participants who are long at higher levels who have not liquidated. This will continue to pressure the market, and it appears likely that the contract low of 3.740 made July 28 will be tested. We have been advising a stand aside posture ever since natural gas generated its short-term buy signal.”

 

Conclusion

When OIA’s protocol generate short and intermediate term signals, the market by OIA’s definition is (1) over bought/sold and (2) a correction of this condition is likely to take place imminently. The benefit to clients is they have an additional frame of reference to assist them with their in-house analytics. If clients buy breakouts, they obtain an edge by utlilizing the 3 day corrective protocol to determine entry points, which decreases the likelihood of getting caught in a major pullback. Regardless, of how markets trade after the generation of buy/sell signals, clients have the benefit of OIA’s price, volume and open interest analysis to know whether the move is likely to be sustained. If  markets continue to move higher/lower (without correcting) after the generation of buy/sell signal(s), our underlying philosophy remains the same, only the timing of the pullback changes.