At the Edge of Chaos: October Surprise – Liquidity Evaporates, Buyers Disappear, Short Sellers Surge, Bullish Setup in Energy

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The Fed is about to get its wish, as the stock market is showing the ominous signs that lead to significant losses. Hint: short sellers are increasing, and buyers are walking away.

The negative scenario I described in last week’s “Elvis Has Left the Building” post was slow to develop, but, by Friday’s employment data release, the new team on Wall Street — short sellers and outright sellers — were back in charge, just as the relative stability in liquidity we had seen for the past few days suddenly fell off a cliff. All of which added up to a Black Friday in the stock market.

It could get worse.

I’ll have more on the overall stock market just below. But first, I’d like to discuss the status of the energy markets, which are simultaneously poised to be a potential bright spot in what could be a dismal stock market.

Pre-Winter Energy Summary

Conditions are nearly perfect for a winter rally in the energy sector, thanks to supply challenges when the weather turns cold in Europe and North America. Moreover, the situation in Ukraine is showing signs of worsening, adding more uncertainty. If the winter is cold enough, or even if it’s just normal, the expectations for a widespread energy crisis which may be proven correct.

It’s Always a Supply Issue

Energy prices are determined primarily by supply. During periods of tight supplies, as in the present, normal or increasing demand usually leads to higher prices.

Aside from the fact that Europe’s natural gas supply is compromised, consider the following. According to the U.S. Energy Agency (EIA):

  • More U.S. oil wells are being completed, but the number of new wells drilled is falling. This adds up to limited supply coming on line just as demand is likely to rise.
  • Current U.S. oil inventories 3% below their five-year average.
  • U.S. gasoline inventories are 9% below their five-year average.
  • U.S. diesel inventories (heating oil) are 21% below their five-year average.
  • Natural gas inventories are higher than earlier in the year, but still 5% below last year and nearly 8% lower than the five year average.

Electricity and Gasoline in Tight Focus

For the everyday person, their electricity bills and the prices at the gasoline pump are all that matters.

Electricity prices are influenced by a combination of the supply of power provided by the primary fuels used to run electric plants: renewables (sun, wind, hydroelectric), natural gas and coal.

Crude oil, which is primarily used in gasoline, diesel and related fuels (such as propane) in the Western world, is primarily of use is in transportation, but can also be used as a last resort feedstock for electricity generation. Although crude oil remains central to the energy market, its market distorted by government interventions such as attempted price caps in Europe and Strategic Petroleum Reserve drawdowns in the U.S., prices have been subdued. The decline in prices has been fueled by expectations of a global recession due to higher interest rates and a subsequent decrease in demand.

Gasoline prices are driven by crude oil supplies, refinery capacity, federal and state taxes and demand.

Supplies are very tight for all fossil fuels in the U.S. and Europe. Moreover, because of the long-standing drought in the Western and Southwest U.S., as well as throughout Europe, water supplies are increasingly tight, decreasing the potential for hydroelectric power generation. And, as Texas found out in 2021, cloudy days don’t help. And when there is no wind, or when it gets very cold, turbines don’t generate power.  

Oil refineries are running at nearly maximum capacity. Some states are raising gasoline taxes. California is planning to tax oil companies for alleged price gouging.

Buckle up!

Change is Brewing

In response to the West’s geopolitical maneuvering against Russia and the subsequent decline in the price of oil, OPEC+ (which includes Russia) has recently announced a 2 million barrel per-day production cut, and crude prices have stabilized.

As a result, the U.S. shale belt is once again seen as a place to go for rescue. Except this time, as I noted above, shale companies are not responding with increased production, due to government restrictions on drilling and potential bans on exports and a renewed focus toward profitability instead of debt-based growth.

Somewhere in the mix is nuclear power, which is slowly making a comeback, but won’t provide a viable substitute for any other fuel in the present due to the time required to build new plants and rehabilitate older ones that have been idled. Coal is in a similar spot, as its production has topped out. Certainly, its use remains stable in many areas, and is growing in others as the issues with oil, gas and nuclear make it a viable option for electrical plants. But, again, supply is limited.

The Long Term in Energy Favors Oil and Gas Exploration

If you look at price charts, you have to wonder if any of those factors that I described above mean anything at all, as the price for natural gas and crude oil are well off of their Ukraine war-related highs. It will be interesting to see what happens as the situation in Ukraine shifts.

West Texas Intermediate Crude (WTIC) is still in a bear market, trading below its 200-day moving average, with the $95-$100 price area looming above as a potential test. But Friday’s action suggest that this may be about to change. A sustained move above $100 would confirm my bullish expectations.

Natural gas (NATGAS) has also come down quite a bit, but has remained above its 200-day moving average, which puts it technically in a bull market. This week could be a decider here as well.

Gasoline is steadily improving and is now in a bullish accumulation pattern, with ADI and OBV both rising. The price is about to emerge above a large VBP bar at $2.50. A move toward $3 is quite possible under the right circumstances here.

The real action has been in the oil exploration sector (DJSOEP), which, despite its recent pullback, is once again near its recent highs. So even if, in the present, prices depend on weather and on the demand side in the face of tight supplies, the big money seems to be moving in on exploration.

Welcome to the Edge of Chaos:

The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder.” – Complexity Labs

I’ve recently added several energy sector picks to my Momentum Plus Portfolio. You can check them out here.

Black Friday: Breadth Rolls Over and Makes New Lows as Put Buyers Return in Force and Liquidity Falls off a Cliff

The buyers are gone. The short sellers are in control. And liquidity has dried up.

The New York Stock Exchange Advance Decline line (NYAD) made a marginal new low as the CBOE Volatility Index (VIX) rallied and liquidity collapsed.

Rising put option volume (VIX) led market makers to sell stock index futures and increase the selling pressure on a market, which is being talked down by the Federal Reserve.

Making matters worse, the Eurodollar Index (XED) broke down after several days of showing signs of being stable. With no liquidity and buyers fleeing, the heavy hand of short sellers will be felt with more power and strength than otherwise.

The S&P 500 (SPX) reversed its early-week rally with a vengeance at week’s end as liquidity dried up. Accumulation Distribution (ADI) and On Balance Volume (OBV) both turned south on Friday after the employment report, which means that short sellers and actual sellers are now on the same page, suggesting a new down leg in stocks is on the way.

The Nasdaq 100 index (NDX) also got crushed although it did not make a new low. Barring a swift turn around, expect new lows here as well.

To get the latest up-to-date information on options trading, check out Options Trading for Dummies, now in its 4th Edition – Get Your Copy Now! Now also available in Audible audiobook format!

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Good news! I’ve made my NYAD-Complexity – Chaos chart (featured on my YD5 videos) and a few other favorites public. You can find them here.

Joe Duarte

In The Money Options


Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.

The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as a Washington Post Color of Money Book of the Month.

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