Crude oil trading has always been a popular choice for traders due to its volatility and global importance. However, to succeed in this market, it is essential to backtest your strategy based on historical data, market trends, and key metrics like Open Interest (OI) and volume. In this blog, we’ll walk you through a backtesting session for crude oil that includes identifying support and resistance levels, analyzing OI changes, and interpreting market data effectively.
1. Timing is Key: When to Start Backtesting?
To ensure you’re working with accurate and updated data, it is essential to begin backtesting after 7:30 PM. Starting earlier may not provide you with the best representation of the market trends. When trading crude oil, especially for intraday positions, the market is particularly active between 4:30 PM and 5:30 PM.
2. Support and Resistance Levels: The First Line of Defense
In this session, the support level is identified at 5900, while resistance is also seen around the same mark. These levels are crucial as they give us insight into how the market might behave. The strength of the support level is calculated based on the OI change and volume at this point.
For example, the support at 5900 has a weaker OI of 1.8K compared to a higher OI at the resistance of 7.3K. When the OI change at a particular strike price is more than double compared to the opposite direction, it is a signal that the market is highly bearish.
3. Understanding OI Change and PCR for Market Direction
OI (Open Interest) is a vital metric in determining market sentiment. In this case, a 2X difference between OI changes on opposite sides at the same strike price (5900) signals a bearish market. To confirm, you can also check the Put-Call Ratio (PCR). Here, the PCR is 0.3, which supports the bearish sentiment further, as values below 0.5 indicate market weakness.
4. Targeting 5850: A Conservative Yet Effective Strategy
Based on the support at 5900 and the overall bearish sentiment, a good target to aim for in this situation is the 5850 support level. Intraday traders will often look for maximum profit, and hitting these support levels in a bearish market is an ideal goal.
5. Using 15-Minute Candles for Entry and Exit
When you’re in the process of backtesting and trading, relying on 15-minute candles can provide clarity. The idea is to make decisions based on the closing of these candles. For example, if a candle closes below 5900, you may want to consider entering a bearish trade, such as buying a put option. If the market retraces and closes above your resistance, it’s a signal to exit.
6. Risk Management: Exiting Based on SL and Candle Close
Risk management plays a crucial role in this strategy. If you enter a trade based on a bearish signal, ensure you have a stop-loss (SL) in place. For instance, setting your SL at 5916, slightly above the resistance level, can help protect your position from unexpected market movements. If the 15-minute candle closes above this level, it’s wise to exit the trade.
7. Handling the Inventory Data Effectively
One of the unique aspects of crude oil trading is dealing with the inventory data that comes out every Wednesday at 7:30 PM. This data can significantly impact market movements, as it reflects the supply levels of crude oil. If the actual inventory levels exceed estimates, it’s a bearish signal, meaning the price might fall. Conversely, if actual storage levels are less than estimated, it’s a bullish indicator.
For example, if the forecast was -6.9 million barrels, but the actual storage is only -0.6 million, the demand has dropped, making the market bearish. Traders should pay attention to these data releases as they can drive sharp market reactions.
8. Volume and Resistance Fight: A Critical Component
In addition to OI and PCR, the volume also plays a significant role in crude oil trading. During this session, you might notice that the volume at the resistance level increases, indicating market participants are entering trades around 5900. If the market fails to break through this level and retraces, it confirms that the resistance is holding strong.
9. Backtesting in Replay Mode: Perfecting Your Strategy
Replay mode is an essential tool in backtesting. By simulating market conditions, you can practice entering and exiting trades based on historical data. Draw key levels like 5916 for resistance and 5869 for support, and observe how the market reacts at these points. This helps in sharpening your decision-making skills for real-time trading.
10. Risk vs Reward: Navigating the Crude Oil Terrain
While the market might show some risky patterns, especially during data releases like inventories, understanding the data and interpreting it correctly can give you the upper hand. Make sure you recheck OI changes at key strike prices and take positions only when data favors your direction.
In conclusion, backtesting a crude oil strategy involves more than just looking at price action. Metrics like OI change, PCR, volume, and inventory data all provide crucial insights into market behavior. By starting your analysis at the right time, relying on key indicators, and practicing risk management, you can effectively navigate the often volatile terrain of crude oil trading.
Always remember, the more you backtest and study these signals, the better prepared you will be for live trading.
This guide aims to give you a comprehensive understanding of backtesting crude oil strategies and implementing them effectively. Happy trading!
