Correlation Trading With Crude Oil Futures

In this video I want to follow through with an important concept that I promised I would share with you. We are looking at the stock index futures (you can pick your favorite one, I tend to use the RUSSELL 2000 or the S&P) and I am looking tonight at the RUSSELL here. I also have Crude Oil Futures up on the chart as well.

Crude Oil Futures correlate with the market as a whole

The underlying premise of what I am about to share with you is based on the fact that this market most often over the years has tended to be correlated with each other. They occasionally with deviate. We have some famous well know correlation deviations here back in time here in the early 2005 time frame (marked on my chart at 1:13) as well as right through this area over here which was 2006-2008. What was happening in this area was every time Crude Oil Futures would go up in price, it was deemed to be a tax on the market as a whole. If you recall, back at this time there were a lot of politics involved as well. You would see pictures and videos of mothers holding their young children in their hands at the gas pumps crying. They were crying because they “couldn’t afford to go to work anymore” and gas was $4.00 a barrel. Everyone was mad because the politicians were in bed with the oil companies and all that.

It was a very emotional time, and so you were seeing situations where every tick where Crude Oil prices would go up, it would cause the market to go down. It was deemed to be a natural tax. From there, of course, was the 2008 crash, and as soon as we saw that Crude Oil was finally rebounding the market rebounded with it. Why? At that time, all of a sudden, people saw that Crude Oil Futures were recovering, and that meant that there must be a demand from manufacturing firms to need this item so production must be picking up. People saw this as a telltale sign of the economy recovering. Well, guess what? Sure enough, we look back and now we have even higher gas prices than we did before. With the different perspective and different politics now that makes it ok. As you know, we are off to much higher highs as we stand to go into the future here.

What we see predominantly is that this market has a correlation. This is whether it is a positive or negative based on the political environment and the spins put on it. Currently, they are coordinated with each other. So, what we are doing right now is use that on a daily basis to determine when we are taking Crude Oil  trades how to be more effective in our trades.

Crude Oil Futures trading with a correlation chart

Let’s take a look at an example here that I did last week (on my screen now at 4:06). This is a live trade that I took in the Live Trading Room. We saw that the market was pushing back down (this is Crude Oil) here (on my chart at 4:19) and getting kind of weak. You can see that we have, what we call, railroad tracking. Everything was starting to get back into alignment to the downside. We noticed the opportunity for a breakdown trade and when we got it we start having a really nice sell off here (on my charts now at 4:59). I was trailing my trade there and doing very well with the trade overall. I elected to pull the trigger and bail out of the trade even though it was coming down very nicely. I was only up $750 on the trade at that point.

What I was looking at when I did that was a correlation problem. Let’s take a look at the correlation chart at that time (on my screen at 5:28) so you can understand how I use this. These red and blue lines are the S&P and the RUSSELL and the candlesticks are Crude Oil. Notice that when one was going up and down the other was following. Everything was working the way that it was supposed to. So, when I took my trade the stock index futures had been going down but you’ll notice that once we got into that capitulation phase the Crude Oil looked wonderful but look what happened with the stock index futures (on my charts at 6:13). The stock index futures pushed back to the upside here.

What did I do at this point? I tightened up my stop and walked away with the $750. What’s important to understand with this is that shortly thereafter Crude Oil ended up getting back in sync with the stock index futures and started pushing off right after.

Look for synchronicity when dealing with Crude Oil

It’s great, you can take small contract trades, and you don’t have to trade millions of dollars to have opportunities with the markets. That being said, you have to think like a professional trader or institutional trader and understand some of these different types of correlations, whether the market is currently correlated or not right now. Here in the May 2013 time frame, they are correlated, the stock index futures with Crude Oil. That is how we are using them right now. Had the stock index futures continued to push down at that time I would have stayed with the trade longer and looked to see if we could have made a larger profit.

When we saw that the stock index futures were spiking right back up that was a huge warning sign. Sure enough, you can see how it ended (on my charts at 7:51). In the end, I want you to remember that there’s this correlation factor here that you need to think about and understand. I just put these charts on top of each other and I’m looking for that synchronicity. So, if I am looking for a long side trade in Crude Oil I like to see the stock index futures participating as well. I don’t want to see them doing the exact opposite of each other.

This is a great learning opportunity for you and I wanted to share it. It is one of my favorite correlation trades that I take. If and when we get back to the non-correlated environment that I showed you took place in the 2007-2008 time frame then I’ll be looking at this in the exact opposite way. I’m sure I will inform you if that takes place in the nightly videos.

We’ll look forward to seeing you in the next video.

Leave a comment!
Read previous post:
Lots Of Great Trading This Morning And New Ideas Reviewed Tonight

Well welcome back gang. Rob here with you as we go ahead and close out our wacky and wild Wednesday....

Close