Doing Whatever It Takes in the Crude Oil Market

Asad Dossani

Saudi Arabia pledged to do 'whatever it takes' to the end the crude oil supply glut. Following a terrible week for crude oil, the big producers are naturally worried. The latest data found that, while production had fallen, crude oil exports didn't fall as much. Either countries were getting rid of excess stocks, which would be temporary. Or they weren't actually cutting production, which is more likely. In any case, OPEC and Russia agreed to extend production cuts for the rest of the year.

This reminds me of how central banks have operated in recent years. I recall the president of the European Central Bank, Mario Draghi, claiming he'd do 'whatever it takes' to stabilise the eurozone. What this really meant was more quantitative easing and money printing. Never mind that they had already been doing this for a while. And it hadn't worked. But they would keep going until it did work.

And now OPEC is following the same misguided approach. You see, years ago, OPEC had control over the crude oil market. Their market share was more than 50% at one time. If they cut production, the impact on price was immediate. And it persisted. But today, OPEC's market share is down. And this is largely due to US shale oil producers entering the market.

The problem is that OPEC still believes it has the power it once had. They haven't adjusted to the new reality. With a smaller share of the market, they can't move prices like they used to. And whatever market share they concede through production cuts, the shale oil producers will gladly acquire. This is why the price increases don't last.

OPEC is still in a good position. Countries like Saudi Arabia still have some of the lowest production costs. They may not be able to move prices, but they can retain a large market share.

If there's one key trait that successful traders possess, it's the ability to adapt. It is the ability to adjust to changing market conditions. Those who live in the past are doomed to failure. And that's exactly what's going on with OPEC.

The good news is that we can take advantage. We can use our knowledge to profit from what's happening in the crude oil market. And you can do this by trading futures contracts. I've recently put together a fantastic guide, The Ultimate Guide to Profiting from Derivatives. This guide is your first step to profiting from crude oil and the rest of the derivatives markets.


Market Notes

How Low-Priced Stocks Lead to a High-Risk Portfolio

Last month Equitymaster's blue-chip stock recommendation service StockSelect recommended a stock priced at around Rs 1,500. A subscriber complained...

    Why don't you recommend stocks that are priced below Rs 100?

We received a similar complaint at our short-term trading service, Swing Trader, back in April 2015.

It's the biggest misconception in retail investing: High-priced stocks are expensive and low-priced stocks are cheap. They confuse value with price.

The way most retail investors look at stocks is completely incorrect. They believe a 10-rupee stock can multiply several times. But argue how far a 10,000-rupee stock can go.

Going back to 2012, MRF at Rs 8,000 was the highest-priced stock. Retail investors thought of it as the most expensive stock. But in January 2014, MRF traded at Rs 20,000. And today it is trading at Rs 66,500!

Stocks like MRF, Page industries, Eicher Motors, and Bosch bust the myth of low-priced stocks being cheap. These were high-priced stocks five years back and they are high-priced stocks today. But they have generated solid returns for their investors.

The chart below shows their returns since 2012. Eicher motors rose 1,640%, MRF 575%, Page Industries 475%, and Bosch 200%.

High-Priced Stocks Returns
 Cutting Losses Short in Bosch

Furthermore, retail investors don't like buying one share of a 10,000-rupee stock. With a 10-rupee stock, they could buy 1,000 shares. This gives them the illusion of bucking more gains. But they don't realise a 10% move in both stocks is still a 10% move.

It's true that low-priced stocks with low volumes can double or triple easily given their lower base. But this is just one aspect of a trade. The other aspect, the most important and most ignored, is risk. In exchange for potential high returns, low-priced stocks carry high risk as well.

We have churned the data on some 2,227 stocks from April 2012 to April 2017, and we'd like to pull out an interesting data point for you.

The maximum five-year CAGR return for a stock above Rs 1,000 was 65%. And the maximum return for a stock below Rs 100 was 174%. Low-priced stocks generated 2.6 times the returns of high-priced stocks.

Now, look at the risk perspective. The maximum drawdown a stock above Rs 1,000 saw was -15%. But the maximum drawdown a stock below Rs 100 saw was -68%. A drawdown of 4.5 times higher for low-priced stocks.

So why do low-priced stocks have higher risk and higher returns?

One reason could be volatility stemming from tick size. The minimum tick size for stocks below Rs 15 is 0.01. So the minimum change in a 10-rupee stock is 0.01% (from Rs 10 to Rs 10.01). And a minimum tick size for stocks above Rs 15 is 0.05. So the minimum change in a 10,000-rupee stock is only 0.0005% (from Rs 10,000 to 10,000.05).

Moreover, it is easy for operators to manipulate low-priced stocks. It requires only a few hands to move them vastly. But it requires massive force to move a high priced stock, thus making it difficult to manipulate them.

Retail investors usually ignore the risk aspect of a trade and focus only on the return aspect. This is where they tend to lose.

Watch this space. We will present you with some more interesting data points which accounts for both return and risk. This might change your perception of high-priced stocks.

From The Market Wizards...

"A great trader is like a great athlete. You have to have natural skills, but you have to train yourself how to use them." - M. Schwartz

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