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Natural Gas: Another Look At The Top

08/28/03 12:08:55 PM
by David Penn

Was the summer correction in natural gas only the beginning of an even deeper descent?

Security:   NGU03
Position:   N/A

Mere days ago, I presented the case for a short-term bounce in natural gas futures ("A Head and Shoulder Bottom in Natural Gas"). Most compelling in this argument was the chart pattern itself, which sketched out a complete head and shoulders bottom in natural gas futures' price action from July to the end of August (basis September), though bullish portents also came from a rising MACD, a 20-day exponential moving average than had gone from negative to flat, and the possibility of a long entry opportunity courtesy of Dave Landry's 2/20 EMA breakout system.

What a difference a day makes! The head and shoulders bottom was virtually completed at the time of the article (Aug 22). This meant that prices should have begun moving up immediately. In the abovementioned article, I noted that because prices were at the top end of a trend channel, natural gas was vulnerable to a reversal to the downside. While such a reversal would have negated the head and shoulders bottom, I believed, as long as the trend channel held, the nascent uptrend in natural gas -- which had plummeted from over 6.50 in early June to under 4.75 by July -- remained intact.

This eight-month head and shoulders top suggests that the bear market in natural gas has only just begun. Note the declining money flow from the peak on the left side of the formation to the still-developing shoulder on the right.
Graphic provided by: TradeStation.
But two things have caused me to reconsider even this short-term bullishness in natural gas. Today's (Aug 27) breakdown below the lower edge of the trend channel, it seems to me, confirms that the bear market in natural gas prices is still in effect. But even before today's breakdown, an e-mail exchange with one of our Advantage contributors helped me take a look at natural gas that was both longer-term and closer in focus. (Take a look at Nabeel Qadir's insightful -- Natural Gas: Trading the June Top with the 8-Wave Pattern -- Advantage; July 25, 2003).

It appears that natural gas, which has been subject of a great deal of popular alarm about the prospects of massive shortages (see my article "The Summer Correction in Natural Gas" Advantage, July 24, 2003; or, earlier, "Is It 'Now Time' for Natural Gas?" Advantage; June 19, 2003), may be forming a top that is larger than many have expected. In particular, natural gas price action is worth looking at for the possibility that what has developed since the late days of January 2003 is a massive head and shoulders top. This bearish reversal formation consists of a left shoulder in the price action from early February to the end of March, a head from early April to the peak in June and down to support on a downwardly sloping neckline in late July, and a right shoulder that begins in the price advance of late July. At present, it appears as if this right shoulder has rounded over and is headed toward completion as August draws to a close. A completed right shoulder, given the downwardly sloping neckline of the prospective pattern, would mean September natural gas prices descending to around 4.5.

If this year-to-date head and shoulders top turns out to be valid, then the consequences for natural gas futures will be as dramatic as any commodity move this year -- including the surprising spike in natural gas futures that happened in February. With a formation high above 6.5 and a neckline around 4.5, the mathematics of any breakdown (formation size subtracted from value at the neckline) point unmistakably toward natural gas prices that are lower than anything seen since February 2002, when September 2003 futures were trading at about 2.50. In the context of what increasingly seems to be a mania over looming shortages in natural gas (and the predictably efficiency of capitalism to respond to high prices with increased competition), the opportunities in natural gas could be huge for traders -- even if those opportunities aren't exactly what natural gas bulls have in mind.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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