Crude Oil Brent, similarities between short term trading and the economic cycle phases

Brent futures week review

We have seen interesting movements in Brent this week. As I said in one of my last articles, I see a bullish trend in Brent. It crossed the resistance at 57.21 on Monday after being rejected on Friday the 9th October. Tuesday was a choppy market but it managed to close higher. All the daily highs were rejected from Monday to Wednesday, this was followed by a big fall on Thursday.  Yesterday It fell in the morning but quickly recover and closed at 57.75. You can think about the Friday recovery as a market optimism supported by the output cut policy by the OPEC.  Let’s check the market action on some charts:

    Source: TradingView, Brent Dec17 Future, daily

Here is the chart from the middle of August to yesterday’s close. It failed to rise above the 58.80 level, which I consider really important. I think it was due to profit taking from institutional trading firms. Yesterday upside move confirmed the bullish sentiment. The shadow was really big, which indicates that traders rejected the downside move and they rebalanced their portfolios increasing longs.

     Source: TradingView, Brent Dec17 CFD Oanda, 1 hour

I've used the Brent CFD from OANDA because I don’t have live market data on ICE futures Europe. It´s easier to see how the market rejected and took profits above 58s. The most relevant part of this chart is the price action on the 20th October. The shadows highlighted in yellow show an area where the buying pressure was bigger than the selling one.

Can we compare the financial markets with the economic cycle?

It seems that the economic cycle is reflected in some markets, the best example is the stock market. Some companies are not as affected by the economic cycles as in the past because globalization plays an important role in their PnL, they can struggle in some countries but they can compensate with the profits from other countries or economic areas. Obviously, there is the risk of contagion as we saw in the last financial crisis. Can we see the same phases in trading than in the economic cycle?

      Economic cycle, own elaboration

Let me briefly explain the economic cycle phases:

• Recession: the confidence drops and shows weakness, the inflation peaks, the inventories drop and the production falls.
• Recovery: the stimulative economic policy helps the confidence to rise again, the inflation falls
• Expansion: the confidence increases, the economy grows
• Late cycle: the inflation rises, everyone talks about the economy and investments, the economic policy becomes restrictive

How do the different assets behave in these phases?

• Recession: interest rate futures and bond futures rise (the yields drop), the stock market falls, commodities fall because there are uncertainty and low demand
• Recovery: interest rate futures curve start to change the direction at least in the back of the curve, bonds futures rise but less than before creating resistances, the stock market stars to rise at least in the stocks linked to the economic cycle, commodities go up.
• Expansion: interest rate futures and bond futures fall (the yields rise), the stock market rises, commodities trends up supported by a strong demand.
• Late cycle: short interest rate yields and bond yields rise, stock market tops up, commodities continue the upside move.

Now, I would like to change the following words:

• Recession: Weakness
• Recovery: Accumulation
• Expansion: Strong trend
• Late cycle: top

It seems a simple game but I want to let you understand that it’s all about order flow, I mean supply and demand, buyers vs sellers. Let me start with the accumulation phase. This is the phase in which the price of the asset is cheap but the market participants have doubts about buying the asset. The institutional investors take advantage of their big portfolios and they start buying and building a long position. Once it has gone up a bit, the economy has improved and shows signs to keep improving, the asset will be in the expansion phase. The main characteristic is that everyone tries to get into the asset and a strong trend is made. After this, there is a late cycle or a top. Everybody talks about how good the asset is performing and some people try to get into it. Sadly, it’s not the best decision as the movement is almost finished. The institutional investors usually take profits during the expansion phase.

Light Sweet Crude Oil example

     Source: TradingView, Light Sweet Crude Oil futures, 15 min

The purpose of this chart is showing what I explain above. It fell in the morning, weakness phase. After that, the accumulation phase started. Around 15:00, the buying pressure pushed the price up. This represents the expansion phase. Between 16:00 and 15:00, the market couldn’t break the 51.60 level, this confirmed the late cycle in which the market topped and failed to break highs. I do apologize because it’s not the best example to show the concept explained.

Conclusion

I hope you have enjoyed this article. It’s not as big as I would like. Please let me know if you would like me to explain each concept in more detail and I will try to do it in the future. As you can see, trading is not as simple as buy low and sell high. There are a lot of things you should consider. 

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved