Two completely different news releases are due today, but from a trader’s perspective, they have something in common. This morning, at 10:30, the U.S. Energy Information Administration (EIA) will release their weekly oil inventory report. Early this afternoon, the Federal Reserve’s Open Market Committee (FOMC), the main policy setting arm of the central bank, will report on their latest two-day meeting, with Chair Jay Powell giving a press conference shortly thereafter. What these two seemingly unrelated stories have in common is that in both cases, traders are pretty sure they know what’s coming, but that doesn’t mean that I will be jumping into the obvious trade in either case.
Advance knowledge of what to expect from the EIA numbers is nothing new in the oil market. In fact, it happens every week. The official government oil inventory report is released every Wednesday at 10:30 a.m., but it is foreshadowed by the private sector’s American Petroleum Institute (API) report that is released on Tuesday afternoon. The two don’t always agree, but at the very least, the API report usually gives advance warning of any major shift in supply and demand trends.
Yesterday’s release seemed to do just that. A significant build in crude oil inventories reported to the API hints at a slowing of demand for gasoline. Up until now, consumers have continued to travel and therefore buy gas in the face of rising prices, but a tipping point had to be reached if prices at the pump continued to climb. The API inventory report indicates that we have reached it. As a result, everyone who trades in or follows crude futures believes they know what the EIA report today will say, and crude futures (CL) have lost over a dollar since the release yesterday afternoon.
Everyone also believes they know what the Fed will say in its statement and subsequent comments today. The committee members have hinted that today will be the day when they announce how and when they will start to reduce their bond purchases. If that were seen as an indication that rate hikes were coming soon, it would have caused some serious selling, but that isn’t the case. Powell has said on several occasions that the two things weren’t necessarily related, and the major indices have continued to edge up as the release has drawn near.
So, it would seem to make sense for traders to go into the EIA oil numbers short crude, and the Fed release long equities, right? The API have already let the cat out of the bag, and everyone is expecting a big draw on crude inventories, while the Fed has basically told us what they are going to do, and the market is happy with it.
There is, however, an inherent problem with trading on obvious things like that.
Over forty years or so of experience, I have learned that the single most important factor in long-term profitability for traders is not how smart they are, or how fast, or how brave, or anything like that. It is much simpler than that. Those who survive over time are those who set up trades to make more when they win than they stand to lose when they lose, and then sticking to that plan. That way, you can ride out volatility and deal with the unexpected when it comes, but still make money if only half of your ideas pan out, which, statistically speaking, is the least you can expect.
When everyone thinks they know what is coming and is positioned accordingly, it sets up the opposite to that desired scenario. Those that want to buy or sell already have, so if the news comes out as expected, the chances of an exaggerated move in the expected direction are slim. There is even a chance of a “buy the rumor, sell the fact” pattern as traders take profits on those early positions, and, if the news is anything but what is expected, there will be a massive move in the other direction. There is a limited upside to an obvious trade, with a big downside potential.
With the Fed release, which is about words rather than numbers, that applies even if the substance is as expected. Any incidental talk about tapering purchases being a precursor to rate hikes, even if it is made clear that that would be in the future, could spark some pretty serious short-term selling. The expected platitudes, on the other hand will produce a shrug of the shoulders.
The EIA oil report is hard data rather than words, but that doesn’t mean that it is without nuance. It is more detailed that the API version in terms of pull through by refiners, crude output, and other factors and any one of those or a combination could show that the inventory decline has a cause other than lower gasoline demand. If that were the case, crude would bounce back quickly and strongly.
So, with major releases coming this morning in the two markets that I currently follow most closely, oil and stocks, I will be sitting on my hands. I had a short CL position that I established a couple of days ago at 84.60 that I will be squaring up this morning, and I am already square in stock index futures and will stay that way until the Fed has said what they will. It may seem like a no-brainer to be trading into news when it is obvious what that news will be, but in fact, avoiding those trades makes far more sense.
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