The last 12 months or so have been a crazy time for oil…
Production cuts by the Organization of the Petroleum Exporting Countries (OPEC) have caused a squeeze in supply.
On the other side, mixed economic data both in the U.S. and abroad has made it difficult to gauge the underlying demand for oil.
That’s all before you add the unfolding geopolitical tensions in the Middle East.
So let’s look at the Energy Select Sector SPDR Fund (XLE). It’s an ETF that invests in a range of oil and gas stocks.
Despite all the factors driving big swings in the oil price, XLE is trading right around the same level as it was at the start of the year.
This type of volatility might put some people off, but today I want to look at how we can trade it…
Extra Confirmation
There are two technical indicators on the chart of XLE below…
First, the blue lines mark the Bollinger Bands. This indicator shows where we can expect most of a stock’s movement.
The 20-day moving average (MA, orange line) shows the overall trend. And the two blue lines sit two standard deviations above and below the 20-day MA.
In simple terms, that means around 95% of XLE’s price action occurs within these two lines…
Energy Select Sector SPDR Fund (XLE)
Source: e-Signal
This is useful because it shows when a price is trading at extremes.
When the price approaches one of the blue lines, that’s a signal it could retreat toward the orange line again. That could provide the setup for a potential mean reversion trade.
But just because a stock is trading at an extreme, there’s no guarantee that it will reverse.
You can see an example when XLE was rallying back in November of last year and then in January of 2023 – or when XLE fell from February through March.
In any of these scenarios, if you’d only used Bollinger Bands, you would have lost money.
So that’s where our second indicator, the relative strength index (RSI), fits into the picture…
The RSI looks for changes in momentum. That gives us an extra layer of confirmation about the move we’re looking for.
Adding these two signals together (Bollinger Bands and RSI) will vastly improve your chances of success with mean reversion trading.
So what am I looking for next with XLE?
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Looking for a Combination
The circles in the bottom half of the chart show a few examples of when both of these indicators are “lighting up”…
Take another look:
Energy Select Sector SPDR Fund (XLE)
Source: e-Signal
In March, June, and October, the RSI formed a “V” (orange circles) and rallied from near-oversold territory (lower gray dashed line).
This action in the RSI coincided with XLE rebounding higher off the lower blue line…
As the red circle shows, these two indicators can also work when the RSI is bouncing off support (green line).
Just remember to look for a momentum reversal (RSI) when the stock is trading near its extremes.
And that’s what I’ll be watching for from here…
Right now, XLE is closing in on the lower blue line.
If the RSI forms a “V” and rallies while XLE nears the lower blue line, that could set XLE for a potential long trade.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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Do you ever use Bollinger Bands as well as RSI to trade? Let us know at [email protected].