Why Technical Analysis matters for energy markets

Energy markets, even futures markets, have historically been driven by fundamentals. The advent of big data and the democratisation of fundamental analysis has only exacerbated this tendency. Spot market prices hinge on weather forecasts, traders furiously check climatology charts in search of omens for renewable production for the next season. In the US, oil and gas analysts have become virtual storm chasers, attempting to predict how hurricanes and tornadoes will affect their trading strategies. 

That energy and its associated commodities are primarily fundamentals driven isn’t startling, nor hard to understand. But the fact is that fundamental driven analysis leaves out an essential component for predicting market: the behaviour and psychology of market actors. This is where the toolkit used by practitioners of technical analysis comes into play. 

“Technical Analysis is how the markets and players are treating fundamental analysis.” says Tom Hovik, Montel’s resident Technical Analyst. The name can be a bit of misnomer: in reality, the practice is more like crowd psychology mixed with applied mathematics. The FT Alphaville blog, among others, has suggested it could be called emotional or psychological analysis. It involves, as Tom says, reading charts and looking for “hidden information” that can help understand where prices are going, based on where they’ve been. Reading the tea leaves? Not exactly, says Tom. ”I have to defend mathematically why I tell some players to buy and some players to sell... It’s not gut feeling as one thinks.” 

Technical analysis as a discipline dates back to the late 1800s and one Charles Dow, a journalist who founded both The Wall Street Journal and the Dow Jones Index that bears his name. He created an index of major stocks that he called the Dow Jones Industrial Average, which he monitored daily. Over time he observed trends and patterns which he documented, ex-post, in analytical articles explaining how market events could be predicted by trading patterns. Form these observations he developed the Dow Theory, with which he could predict highs and lows through market averages. The theory was never formally explained – and perhaps never fully understood – but has been developed and expanded upon over the years by many different economists. Dow’s Theory is the basis of the modern technical analysis toolkit.  

"I try to tell my clients to hold the right positions” Tom says. From the charts (“I only look at the charts”) he’s able to extract information on prices, trends, and the more illusive concept of ‘momentum’. He doesn’t rely entirely on algorithmic calculations – what's known as system trading – but also on his own experience and observations to draw his conclusions about where the market is most likely to be heading. Then, depending on the objectives of the client, he offers advice. “Either to be long or short, or sometimes also to stay away from the market.” The advice he gives to each client will differ depending on what approach the client has to the market. “For example, the guy I talk to in the southern part of Europe every three to four weeks, he’s a long-term player, he tries to figure out what might happen in the next 6-9 months. The intraday traders I talk to have no interest in what happens in that timeframe, but they certainly want to know what will potentially be happening today.”  

Tom’s been working in technical analysis for 36 years, with over 20 of those in energy markets, so he’s witnessed first-hand the change in attitudes. “The chart, 15 years ago, was not looked at much,” but now more and more players take it seriously, he says, mainly because it creates profit opportunities and cost savings. Even big companies, like the Norwegian oil fund. "They officially said earlier this year that they have been using their own method of Technical Trading since 2005,” explains Tom. 95% of his clients are what he calls “fundamental players”, who evaluate the market based on weather forecasts, temperature, seasonal consumption and so on. “But they see over time that the so-called market sentiment must also be taken into account” he adds. That’s why they ask for the advice of a man who’s more interested in how market players are treating fundamental information.  

As energy markets continue their path towards greater financialisation – with faster paced trading, option-based products and other innovations – Tom thinks the future is bright for practitioners of technical analysis. Markets are infinitely more complex and contain much more information than when he started doing business, he points out, so the angle of the technical analysis approach - “read the players, not the game” - has never been more appealing. “They take it seriously,” he says, smiling, “Because there is a tonne of money to be made and saved if you interpret charts correctly.” 

To find out more about the services Tom offers, you can email him at: hovik@montelgroup.com

You can also read about Technical Analysis and other Montel Advisory Services here