Crude Oil Trading: A strategy that works.

Trading Crude Oil Futures with the OVX
  • Statistically Valid
  • Ease Of Use
  • Simple To Master
  • Robustness
  • Durability
4.0

Summary

Day trading crude oil futures contracts are extremely popular.

But do you really know what you are doing? Are you a customer of the casino, or do you own the casino? The choice is yours.

When day trading crude oil futures contracts, use the OVX or Oil Volatility Index as a directional proxy. Or don’t, and lose your money.

The following trading strategy will keep you on the dominant side of the crude oil market, and provide you with a little-known and seldom-used options volatility model that serves as a reliable trading filter.

Learn to test trading theories. Take control of your future. Stop being a victim.

An Intraday Approach to Trading Crude Oil Futures Contracts

Thanks for reading. Today, let’s talk about developing a consistently reliable approach to trading crude oil futures. And then we will expand from an ‘approach’ into a fully automated trading strategy that you can quickly, and easily implement.

First things first…before we jump into the actual strategy. It is important to note that many TradingSchools.Org readers might not be familiar with crude oil futures contracts. In a nutshell:

  • One contract of crude oil equals 1,000 barrels of crude oil.
  • The minimum price move is .01, or 1 penny.
  • 1 penny in price movement equals $10.

To simplify things, if you purchase a single contract of crude oil for $50.00, and then quickly sell for $50.01, then your profit would be $10.

Crude Oil futures contracts are highly liquid. Typically, a million contracts will trade on any given day.

The best time of day to trade crude oil futures contracts is during the ‘day session’. The day session would be defined as 9 AM (EST) – 11:30 AM (EST). If you trade within this time frame, you will be participating with the majority of the daily trading volume. The advantage of only trading within the day session is that the heavy volume keeps the Bid/Ask spread (usually) at 1 penny.

It is also important to liquidate your crude oil futures contracts before the day session ends. If you do not, then you will be expected to have a maintenance margin of $2,500 – $3,000 per crude oil futures contract.

For the purposes of this blog post, we are going to be only focusing on trading crude oil futures contracts intraday. We do not want any overnight exposure or additional margin requirement. We are looking to get the most trading bang for our trading buck.

An approach to trading crude oil futures contracts

Whenever you are in a trade, you should be asking yourself a simple question — do I currently have a statistical advantage? If you do not, then you are the old lady playing the penny slot machine at the Indian casino. Or the sucker putting his casino chips on red or black. Or the butthead wagering that Bruno ‘The Magnificent’ Beefcake will defeat Rocky via TKO in the 8th round. You are gambling.

When you are gambling, you are making a wager where the house has a statistical advantage. Enough wagers and the house will grind you to nothing.

You don’t want to gamble. You want to own the slot machine, or the Roulette table, or the sports book. But in order to achieve this, you need a statistical edge. Let others play against your edge, and watch them lose.

In a prior blog post, we talked about a simple and robust trading strategy that we applied to the Emini SP500 futures contract. The concept is exceptionally simple. That we only want to be trading in the direction of the dominant trend of the day. We called this strategy, the Mid-Point trading strategy. You can read all about that trading strategy here.

In an additional blog post, we expanded the concept of the Mid-Point trading strategy with a VIX volatility filter. The end result was a fully functional trading strategy.

Today, let’s take the Mid-Point trading strategy and apply the strategy to the crude oil futures contract.

Exact Rules

Using only the day session of the crude oil futures contract, we are going to be only focusing on the Buy side, or the Long side.

Entry rules as follows:

  • Wait 2 hours after the market opens.
  • Calculate the Mid-Point of the daily range.
  • When the low of a 5-minute bar crosses the Mid-Point, then we want to buy Crude Oil at the market.

Exit rules as follows:

  • If the high of a 5-minute bar crosses below the Mid-Point, then exit the trade at the market.
  • Exit the trade at the close of the day session.

Stupid simple. Nothing fancy here. Let’s take a look at the results:

Crude Oil Trading

Crude Oil Trading with a stupid simple entry technique.

Now let’s take a closer look at the individual trade performance:

Crude Oil Trading Strategy

2,443 trades, Ave Trade $65, $10k drawdown. Can we improve?

The first thing that should jump off the screen is the sample size. With a total 2,433 trades and an average trade size of $65 per trade, this is way beyond a random outcome. What is so promising is that the sample size gives us plenty of latitude to add an additional filter. We don’t need this much tortilla to make a delicious burrito. We need just enough tortilla to keep this thing together, keep it stable, make it tasty enough to eat.

How can we improve individual trading performance? And how can we do this without over optimization? How can we preserve the underlying logic, without overfitting and introducing the chance of a random outcome?

For this particular strategy, I would like to introduce a volatility filter, specifically the OVX.

What is the OVX?

Many readers are probably scratching their heads and wondering, “what in the hell is the OVX?”

The OVX (Oil Vix) was introduced by Chicago Board of Trade back in 2008. It is a measurement of the expected 30-day volatility of crude oil prices by applying the VIX calculation to the USO or United States Oil Fund. The calculation encompasses a broad spectrum of options prices.

The calculation encompasses a broad spectrum of options prices. I know, it sure sounds confusing. But don’t let it!

In a nutshell, when the OVX is down, then fear is leaving the oil market. And we can reasonably expect a rally in oil prices.

When the OVX is up, then fear has entered the market, and we can reasonably expect oil prices to drop.

Like the VIX, the OVX is not a perfect predictor. But in the land of the blind, the one-eyed man is king.

Is there any scientific evidence that supports the theory that the OVX can predict crude oil prices? Yes. In fact, there have been several academic findings to support the theory. I don’t expect the audience to quickly understand the calculations referenced in the article. I simply peeled out the theory, and then tested the theory on my own platform, using my own data.

Crude Oil Trading Strategy: Using the OVX as a filter

Ok, so lets now take our original Mid-Point trading strategy and add the OVX as a filter. Exact rules as follows:

  • Wait 2 hours after the market opens.
  • If the OVX is down 2%
  • Calculate the Mid-Point of the daily range of crude oil.
  • When the low of a 5-minute bar crosses the Mid-Point, then we want to buy Crude Oil at the market.

Exit rules as follows:

  • If the high of a 5-minute bar crosses below the Mid-Point, then exit the trade at the market.
  • Exit the trade at the close of the day session.

Crude Oil Basic Trading Strategy

Now let’s take a closer look at the individual trade performance:

Crude Oil Trading Strategies

By introducing a volatility filter, our profit jumps higher.

Now we are looking at something nice. Our average trades size has jumped from $65 to $126 per trade. We have reduced the sample size of trades to what I consider to be the “sweet spot” of 200 trades. And most importantly, our drawdown has decreased from $10k to $2.7k. A major improvement.

When to turn this strategy OFF

All strategies break. The markets are efficient, other participants will eventually find this edge and attempt to exploit it. Once this happens, then the edge disappears. So you need to have a mechanism in place, that shuts the system off.

If you notice on the above equity curve, there is a blue line. This line is a 100-period moving average of the equity curve. Once the real-time performance pierces the equity curve–the gig is up. The edge is gone. Probably never to return. So it’s important to have this already in place.

Wrapping things up

Once again, thanks for reading. A bit of a long post. And truth be told, I am a horrible technical writer. Applying an explanation to the obscure is definitely not my strong suit.

The key takeaway is that if an ex-con, high school dropout with little math skills can figure this stuff out…then so can you. You don’t need a bunch of fancy indicators or a mentor that runs a 5 trillion dollar hedge fund. You just need to sit down and start asking questions of the data. The answers are in plain site. But you have to ask the questions.

Once you start to ask questions…your imagination will take root. Your questions will turn into a fever swamp of research and discovery. You will become quickly obsessed, who in the hell knows where your research will lead.

But the key is research and testing.

Another fruitful benefit of testing and researching…you will quickly discover what does not work. When some trading guru professes that his “institutional order flow, hyper delta gamma kappa trading indicator is flashing a buy signal…you can pause and test the theory.

That’s it for today. If you have any questions or need any help testing your theories or ideas…please reach out. I can program just about any idea in a few minutes.

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61 Comments on "Crude Oil Trading: A strategy that works."

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Ingo
Guest

Very interesting, Emmet! I’d like to backtest this strategy in R. Where can I get intra day historical data of OVX? Did you buy the data directly on the CBOE website?
Cheers Ingo

ulysses
Guest
nice stuff Emmet! I’d personally recommend using Fibo lines for deriving a session midpoint, whereas a 50% level acts as a session midpoint and 61.8% will serve as Line In Sand (LIS) with your stops (which is a must as we don’t trade in news vacuum…) just a few ticks (two or three ticks will do the job for ES) below the LIS. If LIS gets broken, consider the intraday trend being broken, too, call it the day and come back tomorrow. You my try and finetune this approach even further, e.g. wait for the price to come back to… Read more »
RobR
Guest

You’re going Long when $TICK is at least -400? I prefer $TICK high for Longs. But of the internals indicators I prefer the A/D line and upvol-dvol more. When they’re above or below zero or have made clear reversals in trend i trade in the direction of the trend only. I wish I had the programming and backtesting skills because I have several fairly similar setups to Emmett’s posts I’d like to test

dtchurn
Guest

So you are just using these internals for entry RobB? I’m just surprised because I thought you didn’t like daytrading anymore. btw, did you happen to attend Peter Rescnik’s”Shadowtraders” chatroom on Thinkorswim? Those internals are what he uses everyday in his screenshare. Just curious, I’m sure you know what you’re doing far more than that bs artist just calling movement as it happens, and his hindsight babble.

Rob B
Guest

Dtchurn,

That is not me!!!!! That is RobR

dtchurn
Guest

Sorry RobB. I have had so much distraction of the constantly lying and instigating pest’s stinking alter disguises’ guttysnipes, my tired vision got confused with the legit id’s mistaken someone else for you.

Mike M
Guest

dtchurn, you are going to need a vacation after all your posts. lol. You better check your blood pressure. I got so angry when that TST shill attacked everyone for just being opinionated. I know how it feels.

dtchurn
Guest
Thanks MikeM, I was going to take a break awhile back and then the gollum and his alter tag team tried to kick me on the way out just because I mentioned in a few words going back to “+” trading. But now drchump, drchumpNO and drchum have all been exposed as gollumespite taking snipes in their gut post way, everyone’s on to it by now, so maybe I can breath easy and take that longer break. I’ve done my part against the shilling and the alters attempting to undermine the truthful posting such as that ridiculous implication that RobB… Read more »
Cyn
Guest

“RobR”, not “Rob B”. Different folks.

dtchurn
Guest

Shoot, I missed that. First time I’d seen a RobR, unless it’s a typo. I don’t have the best vision, and crammed windows in tiny rez with my trading screens.

ulysses
Guest
I should have said that my first comment was about trading ES emini futrures, not CL (oil), thoiugh obvious for experiencd folks but probably not as clean not for newbies. Yeah, I dont wanna be a seller of low TICK, as I dont wanna be a buyer of high TICK, correct. When you sell low TICK is like pushing down a ballon, which is already deep enough under water and prone to shoot up any second. I will need to see TICK making at least -400 AND the price being at a predetermined level of interest where I planned to… Read more »
dtchurn
Guest
I remember this sham artist, TomGentile of the former team of of the legacy sham, “Optionetics” said in one of their “educational” cd’s: “When the VIX is low, it’s time to go. When the VIX is high, it’s time to buy”. Supposedly part of his self-proclaimed “contrarian” trading style. Of course these shams never teach the timing or wherewithal to pull it off because they are still simmy shamshows, but then they try to sell you an affiliate software such as AdvGET costing thousands to “enter” on a wave4,5 and then their ghost forum only has a few complaints that… Read more »
John
Guest

Which software are you using for testing?

Cyn
Guest
I am not sure that your description is clear, so I am going to rewrite it as I understand it. Please confirm whether or not my rewrite is correct. 1. At 0900 ET, when the “day session” opens, calculate the midpoint of the range from 0700 ET to 0900ET. 2. If during the day, the OVX is down by 2 percentage points, we prepare for a long trade entry. (Example: if OVX drops from 15% to 13%, that is a drop of 2%). 3. At the close of the first 5-minute bar whose low is above the Mid-Point, we want… Read more »
Amitc
Guest

Maybe Emmett can post entry/exit chart with both the instruments on the chart, like they say a picture is worth thousand words.

Mike M
Guest
What should stand out to most is the fact that a robust strategy will have draw downs along with days where you will not have a signal. The winning percentage is right in the sweet spot for me at almost 50 percent because I usually couldn’t maintain a strategy where I would lose much more than I win. IMO this will help new traders think for themselves and have realistic expectations when one starts to trade. Most importantly new traders will run away from someone trying to sell them a system that has a winning percentage of 90 with monthly… Read more »
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