If you have followed the stock market for the last year or read the financial news than it’s clear to you that the market will go whatever direction oil is headed. The stock market has always been correlated to the price of oil but right now oil is king and has authority on the direction of the market.
As a trader of US stocks and options, in this environment it is extremely important for me to follow the price of oil before putting on a short-term trade. The volatility in oil will have a highly correlated impact on my trade. This has been increasingly accurate for last past 16 months. Right now I am anticipating a day where oil is no longer king of the castle. I do believe that sooner or later (probably later) the price of oil won’t rule over the stock market like it is today and this will mean that I won’t have to monitor the price of oil as closely. One forward looking question to consider is what sector will take the place of oil as ruler and controller of the markets fate?
When oil prices begin to stabilize the market will find strength or weakness elsewhere. That is why I’m watching banks as closely as I watch oil. The oil industry is also linked to the banking sector and “the financial system must absorb all the short-term negative repercussions from oil at current prices or lower – the bankruptcies, the junk bond defaults, the hit to corporate earnings, the lower growth in emerging markets – before the correlation breaks”, Sumit Roy in Why Stocks & Oil Are Correlated.
The financial sector, as measured by the exchanged trade fund $XLF, showed more relative strength at the end of the week compared to oil, recovering up 12% from it’s low to close, while the United States Oil Fund, $USO only recovered up 7.7% from low to close (see charts below). I don’t know if this is the start of a long term sustainable rally in financials or a smoke-screen to disguise what’s really happening in the economy, like I discussed in “re-evaluating S&P levels“. Like I said the market is guilty until proven innocent so I favor the later point of view for now.
If the market is headed higher next week I think it will be on the back of oil and financials. I’m closely looking at a trade setup in the financial sector. From a technical perspective the chart of $XLF looks like an inverse head-and-shoulder pattern, which is a bullish chart pattern. See chart below. You may wonder why I would be willing to put on a long trade if I believe this is a smoke-screen setup. The answer lies is the word “trade”. This is not an investment. This is a short-term setup which could last a 2-4 weeks. I’m not sure what exact trade I will put on but stay posted as I will share it right here. Symbols to watch, $XLF, $FAS, $SEF, $FAZ, $BAC, $WFC, $JPM.
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