For most investors, there’s nothing wrong with passive investing.  Most of the time, it works just fine: minimizes expenses, avoids “underperformance” and saves taxes.  And, it’s becoming increasingly popular.  JPMorgan estimates that fundamental discretionary traders account for only 10% of daily trading volume.

But, we all remember 2007-2009, when a little market timing would have come in real handy.  Of course, that period was followed by a pretty strong meltup which erased all those nasty losses (and, then some) if one was able to avoid (or, better yet, capitalize on) the volatility during 2015-2016.

Whether active trading is right for you depends on more than market conditions.  What are your cash flow needs?  How much volatility can you stomach?  How aggressive or risk averse are you?  What tax bracket are you in?  And, most importantly, what are the alternatives?

There’s no doubt that active trading is hard.  And, it’s getting harder.  Both fundamentals and technicals seem out of touch with reality half the time.  The rest of the time, they suggest diametrically opposed outcomes.

Recently, a client congratulated me on some decent calls in oil over the past year.  This happened at about the same time that Andy Hall — such a successful oil trader that his nickname was “God” — announced he was closing his fund after sustaining large losses in 2016 and 2017.

How could someone that experienced and savvy do so poorly?  Maybe it was time to go back and see exactly how we had done.  Note: I haven’t tracked performance in anything other than equities, and I’m months behind on tallying that.

Sure, it works in practice.  But, will it work in theory?

I started making active calls in oil (West Texas Intermediate or WTI, symbol CL) futures on October 14, 2014 when CL was 82.27 and falling.  I expected it to continue falling to at least 74 or 64, a target that was lowered many times over the following 16 months (along with many bounces involving higher target prices.)

Had we simply shorted it there and covered yesterday, we’d be sitting on a nice gain of 39.6%.  That would easily rank us in the top 10% of all energy-related hedge funds in terms of performance over the past three years.If we had used the 200-day moving average to signal long/short trades, our return would have improved to about 79% — doubling our outcome with minimal additional effort.

If we used both the 200-day (red) and 20-day (white) moving averages to guide us, the return would have been even better: about 1,772%.Last, utilizing basic Fibonacci patterns, trend lines, moving averages, chart patterns, and (the secret sauce) considering the effect that oil prices have on algorithms, we posted the following buy and sell signals over the past three years.  The buy signals are marked with yellow arrows and the sell signals with red.The net effect was significantly better than either of the moving average approaches and insanely better than the “set and forget” approach.

Again, the point isn’t that active trading will always be more effective than passive or some derivation thereof.  And, I’m certainly not claiming to have found a foolproof way to earn 22,000% over the next three years.

Rather, the point is that active trading can be much more rewarding than passive investing — when incorporating the proper signals.

What are the proper signals?

continued for members…Over the past several years, it has come down to determining what oil prices need to do in order to support stocks and Fed policy goals.

Oil and gas are major components of CPI.  When gas prices soar, so does CPI — as we saw in January and February when YoY increases were 24 and 32%.  CL had rallied sharply into the end of the year in order to support stocks.  But, the resulting inflation effect put the Fed in a bind that could only be resolved by a sharp reversal in gas prices.

Along with various chart patterns, this made it relatively easy to suggest shorting at the end of the month.

At the end of the day, the Fed has no interest in inflation being over 2%.  Higher inflation begets higher interest rates.  And, with over $20 trillion (officially, much more off the books) in debt, we simply cannot afford higher interest rates.  Period.  End of story.  Of course, with interest rates and inflation too low, the value of the dollar starts to sink.  This obviously helps the relative handful of US exporters.  But, the US is an importing nation.  If the dollar plunges, the cost of those imports increases.  That’s right.  More inflation!

Not only that, but depreciating US dollars discourage foreign capital.  Cheap dollars might attract it initially, but the ongoing slump scares investors away.  Note how DXY has been tanking, lately, in the RBOB chart above.

Investors are essentially calling bullshit on the Fed’s promise of more rate hikes in 2017.  Even sugar-coated, the economic news doesn’t begin to support the idea of higher rates.  The relationships between oil, gas, inflation, interest rates and the dollar are important.  But, members know there’s a lot more to this picture.  Oil and gas prices also help drive equity algorithms.  It’s quite common for oil futures to suddenly spike higher when equities are selling off — especially when other algo drivers such as USDJPY and VIX are indisposed.

And, of course, oil and gas pay a certain amount of attention to chart patterns, SMAs, harmonic patters, etc.  So, at the end of the day, we have to make choices regarding all of the above, taking into account the net effect on equities — the most important goal of all!